Deductions vs. Credits

Deductions and credits are two ways to reduce your tax bill, but they work differently. A deduction lowers your taxable income, which can reduce the amount of tax you owe. For example, if you earn $50,000 and have a $5,000 deduction, you'll only be taxed on $45,000. A credit, on the other hand, directly reduces the amount of tax you owe, dollar for dollar. For example, if you owe $5,000 in tax and have a $1,000 credit, your tax bill is reduced to $4,000. In summary, deductions lower income; credits lower tax owed.