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Old 03-21-2007, 10:51 AM
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What is the difference between a tax credit and a tax deduction?What's more valuable?

I was wondering what is more beneficial a tax deduction or a tax credit?



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Old 03-27-2007, 09:17 AM
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A tax deduction is offset against taxable income. For example, if your W-2 Federal wages are $76,000, and you sustained $3,000 of capital losses, this results in a tax deduction of $3,000 leading to $73,000 of taxable income before standard deduction and personal exemptions. Hence, a tax deduction will reduce the amount of taxable income subject to federal income tax.

A tax credit is an amount that is offset against a taxpayers tax liability. Hence lets assume you have a $3,000 tax credit, than assuming you have a tax liablity of $10,000 from say your taxable income of $50,000, the tax credit would reduce your absolute tax liability by $3,000 resulting in a net tax liability of $7,000.

Clearly what this means is that a $3,000 tax credit is more valuable than $3,000 tax deduction. This is because the tax deduction is really worth $3,000 x effective tax rate of the taxpayer, whereas a $3,000 tax credit is worth exactly that amount, $ 3,000!

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