When tax season rolls around, you'll often hear about tax credits and tax deductions as ways to reduce what you owe the IRS. While both can lower your tax bill, they work in fundamentally different ways—and understanding this distinction can save you significant money.

What Are Tax Deductions?

Tax deductions reduce your taxable income. Think of them as lowering the amount of your income that's subject to taxation. The actual tax savings you receive depends on your tax bracket.

For example, if you're in the 22% tax bracket and claim a $1,000 deduction, you'll save $220 on your taxes ($1,000 × 0.22). The higher your tax bracket, the more valuable each deduction becomes.

Common tax deductions include:

  • Standard deduction ($14,600 for single filers in 2024, $29,200 for married couples filing jointly)
  • Mortgage interest
  • State and local taxes (capped at $10,000)
  • Charitable contributions
  • Student loan interest
  • Business expenses for self-employed individuals

Most taxpayers choose between taking the standard deduction or itemizing their deductions—whichever gives them the larger benefit.

What Are Tax Credits?

Tax credits are far more straightforward and typically more valuable. They reduce your tax bill dollar-for-dollar. A $1,000 tax credit cuts your tax liability by exactly $1,000, regardless of your tax bracket.

Tax credits come in two varieties:

Nonrefundable credits can reduce your tax bill to zero, but you won't get any excess back as a refund. If you owe $500 in taxes but have a $1,000 nonrefundable credit, your tax bill drops to zero, but you don't receive the remaining $500.

Refundable credits are even better. If the credit exceeds your tax liability, you'll receive the difference as a refund. Using the same example, you'd get that $500 back.

Common tax credits include:
  • Child Tax Credit (up to $2,000 per qualifying child)
  • Earned Income Tax Credit (refundable, for lower-income workers)
  • American Opportunity Tax Credit (for education expenses)
  • Lifetime Learning Credit (for education expenses)
  • Child and Dependent Care Credit
  • Residential Clean Energy Credit (for solar panels and other improvements)
Which Is More Valuable?

In almost every scenario, tax credits are more valuable than deductions. A $1,000 credit saves you $1,000, while a $1,000 deduction might only save you $220 to $370, depending on your bracket.

However, you don't have to choose between them—you can benefit from both. The key is maximizing whatever tax breaks you're eligible for.

The Bottom Line

Tax deductions lower your taxable income and provide savings based on your tax rate, while tax credits directly reduce what you owe. Credits deliver more bang for your buck, but deductions can still provide meaningful savings, especially if you're in a higher tax bracket or have substantial itemizable expenses.

When preparing your taxes, make sure you're claiming all the credits and deductions you're entitled to. Consider consulting a tax professional if your situation is complex—the money you save often exceeds the cost of professional advice.