Difference Between Tax Credits and Deductions
Tax credit refers to the amount reduced directly from the total tax liability of the person or corporation, whereas, tax deductions are deductions that are allowed to be deducted from the total income of the person or corporation which thereby results in reduction of tax liability by decreasing taxable income not by directly decreasing the tax liability amount.
Tax credits and deductions can aid in reducing the overall income tax liability and is something that all taxpayers want to take advantage of. Tax credits can help to reduce the liability at a dollar to dollar level but cannot reduce overall liability to less than zero. Tax deductions, on the other hand, lower the taxable income and are calculated using the percentage of marginal tax brackets.
What is Tax Credit?
Tax Credit refers to the amount which can be offset against the overall tax obligation. It is the total amount which an assessee can reduce from the taxes payable to the authorities. Its major benefit is it directly reduces the component of tax liability and is directly measured in terms of the respective currency. There are various types of tax credit available:
- Income Tax Credit: When an assessee is charged tax greater than their actual liabilities resulting from various factors, then the surplus amount is available as a tax credit, which can be carried forward to the following financial year and adjusted against subsequent tax obligations. As an alternative, the amount may be paid, and subsequently, the excess amount is credited back in the account of the taxpayer.
- Input Tax Credit: This is the credit available to registered dealers and manufacturers for the inputs they purchase to resell. Recently, the GST (Goods & Service Tax) passed by the Government of India, offers a tax credit to manufacturers who are paying GST of 18% of more. This way, they are encouraged to continue their activities and keep the prices at existing levels or even lower them.
- Foreign Tax Credit: It is a non-refundable tax credit for income taxes paid to a foreign government resulting from income tax withholdings. The tax credit is available to anyone who either has investment incomeInvestment IncomeInvestment income is the earnings made from allocating funds in financial instruments or assets like securities, mutual funds, bonds, property, etc. It includes dividends on bonds and interest received on bank deposits, profits and capital gain from the sale of real estate and securities. from a foreign source or is working in a foreign country. E.g., if a portion of tax payer’s foreign income is taxable and some are exempt, the taxpayerThe TaxpayerA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws. must be able to only claim the credit for taxes paid on foreign income.
What is a Tax Deduction?
Tax deductions are qualified expenses that can reduce the gross taxable income (GTI) either by a specified amount or percentage. The tax authorities make provisions for the same during the commencement of the financial year.
Assesses can claim deductions on various expenses such as:
- Medical expenses for self and family
- Life Insurance Premiums
- Contribution to funds permitted by the Government
- Donations to institutes permitted by the Government etc.;
For instance, as per the Indian Taxation law, if an assessee invests Section 80C, which encourages savings associated with Government, the taxpayer does not have to pay any tax on them, and it also reduces their overall taxable income. The limit here is INR 1, 50,000, which is eligible to be tax-free.
Tax Credit vs. Tax Deduction Infographics
Let’s see the top differences between tax credits vs. tax deductions.
Key Differences Between Tax Credits and Deductions
- A tax deduction is an eligible expense that reduces the table income of the assessee. In contrast, the tax credit is an incentive whereby taxpayers are able to reduce the amount of tax under given circumstances.
- A tax deduction is available to the assessee if a specific expense has been incurred. In contrast, tax credit arises if any excess amount of tax has been deposited with the taxation authorities.
- A tax deduction saves the taxation liability by a small amount since the restriction is imposed on the maximum deduction. In contrast, the tax credit is adjusted by a larger and is calculated on a dollar to dollar basis.
- A tax deduction reduces the taxable income of the assessee, and a tax credit reduces the overall tax liability of the assessee.
|Basis for Comparison||Tax Deduction||Tax Credit|
|Meaning||These are deductions that help in reducing the overall taxable income applicable for tax.||It is a tax incentive whereby the taxpayer is able to deduct the amount of tax under specific circumstances.|
|Benefits||Helps in reducing taxable income||It is an obligation to payment of taxes.|
|Point of adjustment||Adjusted before application of the tax rate;||Adjusted after the tax due is ascertained.|
|Tax Saving||It reduces tax by a marginal percentage.||The tax reduction is applicable on a dollar to dollar basis.|
|Reason of existence||It is offered due to a variety of expenses borne by the taxpayer||It is due to tax already deposited with the tax authorities or specific circumstances.|
Though both these avenues help in reducing the tax burden for any taxpayer, the advantages offered are different, and one should accordingly take advantage of them. A tax deduction is offered to a large number of people and hence will have a minimal impact. The tax credit, on the other hand, offers a precise amount of money for any excess tax paid retrospectively. Thus, the pros and cons should be ascertained accordingly.
Tax Credits vs. Deductions Video
This article has been a guide to tax credits vs. tax deductions. Here we discuss the top differences between them along with infographics and comparative table. You may also have a look at the following articles to learn more –