Tax credits and tax deductions both reduce what you owe, but they work very differently — and a credit is almost always worth more than a deduction of the same dollar amount. Understanding the distinction helps you make better decisions about retirement contributions, healthcare spending, education costs, and what to look for when filing.
How Deductions Work
A tax deduction reduces your taxable income. If you earn $60,000 and claim a $5,000 deduction, you are taxed on $55,000 instead. How much that saves you depends on your tax bracket. In the 22 percent bracket, a $5,000 deduction saves you $1,100. In the 12 percent bracket, the same deduction saves you $600.
Deductions favor higher earners because the same deduction is worth more in a higher tax bracket. Someone in the 37 percent bracket saves $1,850 from that same $5,000 deduction. This is why you often hear that deductions are worth more to high-income taxpayers.
How Credits Work
A tax credit reduces your tax bill directly, dollar for dollar. A $1,000 credit reduces what you owe by $1,000 regardless of your tax bracket. That makes credits far more valuable than deductions of the same amount for most taxpayers.
Credits come in two types. A nonrefundable credit can reduce your tax bill to zero, but you do not receive the remainder if the credit exceeds your tax liability. A refundable credit can reduce your tax bill below zero — meaning the IRS pays you the excess as a refund. The Earned Income Tax Credit and the Additional Child Tax Credit are refundable. The Child and Dependent Care Credit is partially refundable. Most other credits are nonrefundable.
Standard Deduction vs. Itemizing
Every taxpayer can claim either the standard deduction or itemized deductions — whichever is larger. For 2024, the standard deduction is $14,600 for single filers and $29,200 for married filing jointly. If your total itemized deductions do not exceed these amounts, taking the standard deduction is both simpler and more beneficial.
Common Itemized Deductions
Mortgage interest on loans up to $750,000; state and local income, sales, and property taxes (capped at $10,000 combined); charitable contributions; medical expenses exceeding 7.5 percent of adjusted gross income; casualty and theft losses from federally declared disasters. Most people — especially renters — do better with the standard deduction.
Above-the-Line Deductions
Some deductions are available regardless of whether you itemize — these are called above-the-line or “adjustment” deductions. They include: traditional IRA contributions (subject to income limits), student loan interest, contributions to Health Savings Accounts, and self-employment taxes paid. These reduce your adjusted gross income and can also improve eligibility for other tax benefits.
Major Tax Credits and Who Qualifies
Earned Income Tax Credit
Refundable. For working adults with low to moderate income. Worth up to $7,830 for families with three or more children in 2024. One of the largest tax benefits available to lower-income workers. Often missed by people who do not realize they qualify.
Child Tax Credit
Up to $2,000 per qualifying child under 17. Partially refundable (up to $1,700 refundable as the Additional Child Tax Credit). Phases out at higher incomes. A family with two qualifying children can reduce their tax bill by up to $4,000 from this credit alone.
Child and Dependent Care Credit
For expenses paid to care for a child under 13 or a dependent who cannot care for themselves while you work or look for work. Worth 20 to 35 percent of up to $3,000 in expenses for one dependent, or $6,000 for two or more. Partially refundable for lower-income households.
Retirement Savings Credit
Also called the Saver’s Credit. A nonrefundable credit for lower- and moderate-income taxpayers who contribute to a 401(k), IRA, or similar retirement account. Worth 10 to 50 percent of up to $2,000 in contributions (or $4,000 if married filing jointly). Income limits apply.
Premium Tax Credit
Refundable. Helps lower- and moderate-income individuals and families pay for health insurance purchased through the marketplace. The amount is based on your income relative to the federal poverty level and the cost of available plans in your area. You can receive it in advance or claim it when filing.
American Opportunity Credit
For the first four years of college education. Worth up to $2,500 per student per year, with 40 percent refundable. The Lifetime Learning Credit covers additional years and graduate courses but is nonrefundable and smaller. Income limits apply to both.
Which Should You Focus On
If you qualify for any refundable tax credit, claiming it should be the first priority — it directly increases your refund or reduces what you owe regardless of your tax situation. After credits, above-the-line deductions (IRA contributions, HSA contributions) are the most broadly useful because they reduce your AGI and are available whether or not you itemize.
Itemized deductions are worth reviewing carefully if you own a home with a large mortgage, make significant charitable contributions, or have high medical expenses. For most renters and people with straightforward finances, the standard deduction is simpler and larger.
Credit and deduction amounts change annually with inflation adjustments and legislation. Figures here reflect 2024 tax year rules. Verify current limits at IRS.gov or with a qualified tax preparer.