Tax Credit

Main distinction on display here: tax credit vs. tax deduction.

A tax deduction refers to any tax help the government gives that lowers a person's taxable income. You made $60,000 last year. You owe 25% income tax, or $15,000 total. However, you receive a $1,000 tax deduction for your donation to the Puppy Wig Foundation for Balding Dogs. Now you're taxable income is $59,000. The basis the government is using to determine your income tax has shrunk by $1,000. Apply that 25% tax rate...now you owe $14,750.

A tax credit actually lowers your tax bill. This year, the government is offering a $1,000 tax credit for keeping a barrel of toxic waste in your basement. You just happen to have one down there, so you qualify for the program. Your tax base remains $60,000 in this case...the tax credit doesn't impact that. However, your tax liability of $15,000 has been lowered by $1,000. Now you owe $14,000.

The tax credit lowers your tax liability. The tax deduction lowers the income basis used for determining taxes.

Typically, the tax credit would have a bigger impact...a $1,000 tax credit is worth $1,000. The size of the break you get with $1,000 tax deduction will depend on your income and tax rate, but it will have an impact on the bottom line of substantially less than $1,000.