Tax Deduction vs. Tax Credit: Which One Lowers Your Bill the Most?

Key takeaways

• A tax deduction lowers your taxable income — which may reduce how much tax you owe – while a tax credit reduces your tax bill dollar for dollar.
• Credits can have the biggest impact, but deductions are more common and can add up throughout the year.
• Knowing the difference can help you maximize your refund before the filing deadline.

Tax season has a way of sneaking up, but staying organized makes it easier to maximize your deductions. A little organization now can help you claim more of the expenses you qualify for when you file. 

Start by keeping track of receipts and any expenses that might qualify for deductions throughout the year. Understanding how deductions and credits work can help you maximize your refund.

Tax deductions: Lowering your taxable income

A tax deduction reduces the amount of income the IRS taxes.

For example, if you earn $50,000 and qualify for $5,000 in deductions, you’re only taxed on $45,000.

Example: The home office deduction

You may qualify for the home office deduction if you’re self-employed and use part of your home regularly and exclusively, which means only for work. An example would be a dedicated space in your home where you meet with clients or customers, and handle all your emails, scheduling, and billing.

You can deduct a portion of your home expenses like utilities, rent, mortgage interest, depreciation, and maintenance. To work out how much, you compare the square footage of your workspace to the rest of the home. If your office takes up 10% of your home, you can usually deduct 10% of those bills.

If you would rather not keep track of all your home expenses, you can elect to use the simplified method instead. Under this method, you are allowed to deduct $5 per square foot for your office space, but are limited to a maximum of 300 square feet. 

For W-2 employees, the rules are different. Even if you work from home full-time, you generally can’t deduct home office expenses for your job. However, if you have a side gig you work on from home, you might be able to claim the home office deduction for that business if you are self-employed through the side work.

Tax credits: cutting your bill dollar for dollar

Tax credits work differently. They reduce your tax bill itself.

If you owe $2,000 and qualify for a $2,000 credit, your tax bill drops to $0. That’s why credits can feel more impactful.

Example: The American Opportunity Tax Credit (AOTC)

The AOTC can be worth up to $2,500 per eligible student for the first four years of college (as well as being potentially refundable if you don’t owe any tax for up to $1,000). Remember to include required course materials, as things like books, lab fees, and even rented textbooks will count toward your credit.

What are some other common tax deductions and credits?

When it’s time to file, TurboTax will walk you through simple questions to uncover every deduction and credit you’re eligible for. Here are some examples of common deductions and credits:

Deductions:

• Business mileage (available to self-employed taxpayers)
• Self-employed health insurance premiums
• Self-employed retirement plan contributions (such as SEP IRAs, SIMPLE IRAs, and Solo 401(k) plans). 
• Student loan interest deduction
• No tax on tips – up to $25,000
• No tax on overtime – up to $12,500 per year (25,000 if married filing jointly)
• Car loan interest – up to $10,000

Credits:

• Child Tax Credit
• Earned Income Tax Credit
• Lifetime Learning Credit
• Child and Dependent Care Credit

Do tax deductions or credits lower your bill the most?

In most cases, tax credits lower your bill more than deductions. A $2,000 credit typically saves you more than a $2,000 deduction. But deductions are far more common — and easier to accumulate throughout the year.

No matter what financial moves you made last year, TurboTax helps make sure they count. Whether you file your taxes yourself or have a TurboTax expert handle it, you can be confident you’ll get every deduction you qualify for and maximize your refund.