Tax credits directly reduce the amount of tax you owe, giving you a dollar-for-dollar reduction of your tax liability. A tax credit valued at $1,000, for instance, lowers your tax bill by the corresponding $1,000. Deductions lower your taxable income by the percentage of your highest federal income tax bracket.

What is the difference between a tax credit and a deduction?

A deduction can only lower your taxable income and the tax rate that is used to calculate your tax. This can result in a larger refund of your withholding. A credit reduces your tax giving you a larger refund of your withholding, but certain tax credits can give you a refund even if you have no withholding.

Can a tax credit result in negative tax liability?

For example, if your tax liability after deductions works out to $1,500 and you can claim a refundable tax credit for $2,000, you have a negative tax liability of $500. The IRS adds the $500 to any prepaid taxes when figuring your tax refund.

What kind of tax credits can I use to lower my tax liability?

Earned income credit (EIC). This is another credit aimed at lowering the tax liability for working families, especially those with dependent children. There are income limits, but the credit can be generous if you fall into the lower end of the income scale. Retirement savings contribution credit.

How are tax credits and tax deductions related?

Taxpayers sometimes confuse tax credits and tax deductions, perhaps because each has the potential to lower your overall tax liability. But while tax credits are a direct reduction in your tax liability (and can sometimes create a refund where none is otherwise due), tax deductions instead reduce your taxable income.

Can you take a credit larger than the amount you owe on taxes?

Keep in mind, you can’t take a credit larger than the amount of taxes you owe, because the ITC is a “non-refundable” tax credit. You can, however, claim the credit over more than one year, and carry any leftover amount forward to the next year.