Intuit Academy Tax Practice Exam

A tax credit is a direct reduction of the amount of tax owed to the government, which means that for every dollar of credit, the taxpayer's tax liability decreases by the same amount. This is a more beneficial form of tax relief compared to deductions, as credits can lead to a larger impact on the overall tax bill. For instance, if a taxpayer owes $1,000 in taxes and receives a $200 tax credit, their actual payment due becomes $800.

In contrast, a tax deduction lowers the taxable income, which in turn reduces the overall tax liability but not on a dollar-for-dollar basis. The actual tax savings from a deduction depend on the taxpayer's marginal tax rate. For example, if a taxpayer has a deduction of $1,000 and is in a 22% tax bracket, the effective tax relief would only be $220 rather than a full reduction of $1,000 from the tax owed.

Overall, the essential distinction is that a tax credit directly reduces the tax liability, while a deduction decreases the income that attracts tax, influencing the amount owed indirectly.