When it comes time to file your tax return, you want to be sure you don't pay more than your fair share of income tax. Tax deductions and tax credits can help lower your tax bill, and might even increase your refund, but you need to qualify and claim them to benefit. You'll also want to understand how deductions and credits work so you can make smart tax moves throughout the year.1
What Are Tax Deductions?
Tax deductions can decrease your taxable income, which will lower how much you wind up paying in taxes. For example, if you're single and have $50,000 in taxable income, you'll be in the 22 percent tax bracket in 2022.2 Claiming a $1,000 tax deduction will lower your taxable income to $49,000 and save you $220 dollars—22 percent of $1,000.
Standard vs. Itemized Deductions
You can choose to use either the standard deduction or itemize your deductions, and the IRS suggests you use whichever option results in a larger deduction.3
For 2022, the standard deduction ranges from $12,950 to $31,500, depending on your tax filing status, age and whether you're blind.4 The Schedule A of Form 1040 lists all the potential tax deductions that you may be able to itemize, such as:5
- • Mortgage interest payments
- • State and local income, sales and property taxes
- • Medical and dental expenses
- • Charitable contributions
- • Casualty and theft losses from a federally declared disaster
Additional rules and requirements can apply, but you can add up all the itemized deductions you can claim and then compare the sum to your standard deduction to determine which you should use.
Claim Additional Savings With Adjustments to Income
In addition to choosing the standard or itemized deductions, you may be able to lower your taxable income with a type of deduction called an adjustment to income. You can claim all of the adjustments you qualify for in addition to your other deductions.6
Common adjustments to income include:
- • Student loan interest. Deduct up to $2,500 of what you paid in interest toward eligible student loans.
- • IRA and HSA contributions. Amounts, up to a limit, that you contribute to a traditional individual retirement account (IRA) or health savings account (HSA).
- • A portion of your self-employment taxes. You may have to pay self-employment taxes if you own a business or have freelance or contract work, and you can deduct a portion of these tax payments.
- • Educator expenses. A deduction for up to $300—or $600 if you're married, filing jointly and both eligible educators—for qualified expenses, such as books and supplies for your classroom.
The adjustments to income can be particularly beneficial because your taxable income minus these adjustments determine your adjusted gross income (AGI). Your AGI impacts which tax credits and (other) deductions you qualify for, and it can affect your eligibility for financial assistance programs and benefits.
The standard or itemized deductions lower your taxable income, but you apply them after you calculate your AGI.
What Are Tax Credits?
Tax credits can reduce how much income tax you have to pay on a dollar-for-dollar basis. For example, if you're working on your tax return and see that you'll owe $1,500 in federal income tax, and then you realize you can claim a tax credit for $1,000, you'll wind up owing $500.
Refundable vs. Nonrefundable Tax Credits
Tax credits can either be refundable or nonrefundable, which describes how the credit can impact your tax refund.7
- • Nonrefundable credits can lower how much income tax you owe to $0.
- • Refundable credits not only also lower how much you owe, but they can also increase your refund.
For example, if you owe $1,000 in taxes and can claim a $1,500 nonrefundable tax credit, you'll owe zero and won't get a refund. But if the credit is refundable, your refund will increase to $500.
Nonrefundable tax credits sometimes let you use the unclaimed portion of the credit in future years. But, with others, you'll lose out on any amount you don't claim. There are also a couple of partially refundable tax credits—a portion of their value is refundable, but the rest is not.
Examples of Tax Credits
There are many potential tax credits available, each with its own rules, requirements and benefits.8 Some examples include:
- • American Opportunity Tax Credit. An education tax credit worth up to $2,500 for each eligible student who meets all the requirements. Students or their parents might be able to claim the credit, and up to $1,000 (40 percent) is refundable.9
- • Child tax credit. Parents and guardians of children may be able to claim up to $2,000 for each qualifying child (up to $1,500 of that could be refundable) with the child tax credit.10
- • Earned income tax credit. The earned income tax credit, EITC, is a fully refundable tax credit that can help low- to moderate-income tax filers who earn income throughout the year. You can claim the EITC even if your income is below the required amount for filing a tax return, but you need to file your return to claim the credit and get a refund.11
- • Saver's tax credit. You may be able to claim the saver's tax credit if you contributed to a tax-advantaged account, such as an IRA or 401(k). It's worth up to 50 percent of what you contribute, up to a maximum of $1,000, or $2,000 for spouses who file jointly. However, the credit isn't refundable.12
Check the eligibility requirements for each tax credit carefully, and make sure you file the correct associated forms if you can claim a tax credit.
Check the eligibility requirements for each tax credit carefully, and make sure you file the correct associated forms if you can claim a tax credit.
An Overview of Tax Credits vs Tax Deductions
| Tax Credit |
Tax Deductions |
|
| Can decrease how much income tax |
Yes |
Yes |
| Each $1 reduces … |
How much income tax you have to pay |
The income you have to pay taxes on |
| Can increase your refund if |
Only if it's a refundable tax credit |
No |
| Can lower your adjusted |
No |
Only if it's an adjustment to income, sometimes called an above-the-line deduction |
Are Tax Credits Better Than Tax Deductions?
You could consider tax credits to be better than tax deductions because credits lower your tax liability and might increase your refund. However, you don't have to choose between one or the other. You can claim every tax credit and deduction that you're eligible for, and you can make tax moves throughout the year—such as contributing to an IRA—to help you qualify for credits and deductions.
Bottom Line
You can claim tax credits, deductions and adjustments to income to decrease your taxable income and tax liability. Each has its own requirements and rules, and a professional tax preparer and some tax preparation software can help you check your eligibility and claim the correct amounts.
Also, consider what you'll do with your tax refund or savings. Putting the money into a high-yield savings account or certificate of deposit could be a great way to make the money work for you and increase your net worth over time.
Louis DeNicola is a freelance finance writer who loves helping people and small businesses save money. He writers for financial services firms, publishers and tech companies, and lives in Oakland, CA.
LEARN MORE: Video: Key Benefits of Tax Advantaged Accounts
Sources
1. IRS. (January 11, 2023). Credits & Deductions for Individuals.
2. IRS. (November 10, 2021). IRS Provides Tax Inflation Adjustments for Tax Year 2022.
3. IRS. (January 12, 2023). Tax Topic 501 - Capital Gains and Losses.
4. IRS. (2022). Publication 17 - Your Federal Income Tax (For Individuals) - Chapter 1. Standard Deduction.
5. IRS. (January 11, 2023). About Schedule A (Form 1040). Retrieved from
6. IRS. (n.d.). Adjustments to Income.
7. Tax Policy Center. (2022). What is the difference between refundable and nonrefundable credits?
8. IRS. (January 11, 2023). Credits & Deductions for Individuals.
9. IRS. (January 20, 2023). American Opportunity Tax Credit (AOTC).
10. IRS. (August 25, 2022). Child Tax Credit.
11. IRS. (January 11, 2023). Earned Income Tax Credit (EITC).
12. IRS. (December 12, 2022). Retirement Savings Contributions Credit (Saver's Credit).