What is Tax Credit vs Tax Deduction?

Both credits and deductions lower a tax bill, but by very different amounts.

Deductions reduce taxable income

A deduction, such as a business expense or the qualified business income deduction, lowers the income on which tax is calculated. Its value depends on your tax rate. A $1,000 deduction for a taxpayer in a 24% bracket saves about $240 of income tax.

Credits reduce tax directly

A credit reduces tax owed dollar for dollar. A $1,000 credit saves $1,000, regardless of your bracket. Some credits are refundable, meaning they can produce a refund beyond the tax owed; most business credits are nonrefundable and may carry forward.

Business credit examples

• Work Opportunity Tax Credit for hiring from targeted groups
• Credit for small employer pension plan startup costs
• Research credit
• Credit for employer Social Security and Medicare taxes on certain tips

Many business credits are combined into the general business credit on Form 3800, which the IRS describes on its Form 3800 page. Credits often reduce related deductions; for example, a wage-based credit may reduce the wage deduction.

Which is better?

A credit of a given amount is generally worth more than a deduction of the same amount. But deductions are far more common, and eligibility rules for credits can be strict, including deadlines such as the WOTC's 28-day certification rule.

Tracking eligibility

Many credits depend on records kept during the year, such as certifications, hours or qualified expenses. Our tax services review common credits with clients each year. See also marginal vs effective tax rate.

Related terms

• Debits and Credits: Debits and credits are the two sides of every bookkeeping entry; each account type increases on one side and decreases on the other.
• Marginal vs Effective Tax Rate: Your marginal rate is the rate on your next dollar of income; your effective rate is total tax divided by total income.

Browse more definitions in the small business glossary.