How do tax deductions and credits work?

Taxes aren’t exactly most people’s favorite topic. Between the acronyms, the fine print, and the endless “Am I doing this right?” moments, it’s easy to feel overwhelmed. But here’s one truth worth hanging onto: understanding just two tax concepts, deductions and credits, can make a real difference in how much you owe (or get back).

By the end of this article, you’ll understand how each one works, when they matter most, and how to use them to your advantage. 

How does a tax deduction work? 

Let’s start with the basics: a tax deduction reduces the amount of income the IRS can tax. If you earn $75,000 and claim a $10,000 deduction, the IRS treats you like you made $65,000 instead. Lower taxable income = lower tax bill. 

The Deductions Most People Actually Use 

For most taxpayers, deductions fall into one of two camps: 

• Standard deduction: This is the no-math-required option. For 2024, it’s $14,600 for single filers and $29,200 for married couples filing jointly. Most people take it because it’s easier and often higher than their itemized deductions anyway. 
• Itemized deductions: If your deductible expenses add up to more than the standard deduction, itemizing might be worth it. Common ones include: 
  • Mortgage interest 
  • Medical expenses (if they exceed 7.5% of your income) 
  • Charitable donations
  • State and local taxes 

Easy-to-Miss Deductions 

Even if you don’t itemize, some deductions are still on the table. These are known as “above-the-line” deductions and include things like: 

• Student loan interest 
• Traditional IRA or 401(k) contributions 
• Health savings account (HSA) contributions 
• Self-employed business expenses (think: office supplies, software, mileage) 
• Educator expenses ($300 per teacher, $600 for MFJ if both qualify) 

How do tax credits really work? 

Here’s where it gets even better: tax credits don’t just lower your taxable income. They lower your actual tax bill. 

So, if you owe $2,000 in taxes and qualify for a $1,000 credit, your bill drops to $1,000. No percentage math, just real savings. 

Different Types of Credits 

Tax credits come in three flavors: 

• Non-refundable credits: These lower your tax bill but can’t take it below zero. If you owe $500 and have a $1,000 credit, you just wipe out the $500. The rest doesn’t come back to you. 
• Refundable credits: These can take your bill below zero and generate a refund. Yep, you could get money back even if you don’t owe any tax. 
• Partially refundable credits: A mix of both; you get some refund even if your tax bill is already zero 

Common Tax Credits 

There are many different tax credits available. Some you may be familiar with, while others might surprise you. 

For individuals and families: 

• Child Tax Credit 
• Earned Income Tax Credit (EITC) 
• American Opportunity and Lifetime Learning Credits (for education expenses) 
• Premium Tax Credit 

For business owners: 

• Energy-efficient equipment or vehicle credits 
• Research & Development (R&D) credits 
• Work Opportunity Credit (for hiring certain employees) 

Tax Credits vs. Tax Deductions: Who wins? 

Let’s break it down with a quick example: 

Credits generally deliver more bang for your buck. 

But here’s the nuance: deductions can add up, especially for high earners with mortgage interest or big medical expenses. So, while credits are usually more powerful, both tools have value. It depends on your situation. 

How to Maximize Your Tax Savings 

Should you take the standard deduction or itemize? 

Here’s the rule of thumb: itemize only if your itemized deductions are more than your standard deduction. If you’re not sure, plug both into tax software or talk to a pro. It’s worth running the numbers. 

Are you missing out on credits you deserve? 

Here’s a quick list of credits to check for: 

• Kids: Child Tax Credit, Dependent Care Credit 
• School: American Opportunity or Lifetime Learning Credit 
• Business investments: R&D or energy-related credits 
• Home upgrades: Energy-efficient systems or electric vehicle tax breaks 

Keep receipts for big purchases, donations, and anything you plan to deduct or claim. Then, review your tax situation yearly. Credits, especially, can change from one year to the next. 

Personal vs. Business Tax Breaks: What’s the difference? 

Personal tax benefits usually relate to life circumstances: your family, home, education, or retirement savings. 

Business tax benefits, on the other hand, often relate to how you operate or invest in your business. These can include: 

• Deductions for office rent, supplies, or equipment 
• Credits for hiring, training, or sustainability upgrades 

Example: 

• Personal: You claim a credit for childcare. 
• Business: You buy an energy-efficient fridge for your café and deduct the cost and claim a green energy credit. 

Real-Life Examples 

For an Individual 

Let’s say you: 

• Paid $1,500 in student loan interest (deduction) 
• Qualify for a $2,000 education credit 

If you earn $50,000: 

• The deduction might lower your taxable income to $48,500, saving about $330 
• The credit knocks $2,000 off your tax bill directly 

Total savings? Over $2,300. 

For a Business Owner 

You invest in energy-efficient equipment: 

• Deduct $10,000 (lowers taxable business income) 
• Claim a $1,200 clean energy credit 

Depending on your tax rate, that combo could save you thousands, and it’s all legal, smart strategy. 

The Bottom Line 

Deductions lower your taxable income while credits lower your tax bill itself. Both matter, but credits often carry more weight, especially if they’re refundable. Track your expenses and ask a tax professional about any deductions or credits you might be missing. 

It’s not hard to figure out if you have the right info, a little prep, and the confidence to ask questions.