Difference between Tax Deduction and Tax Credits

Several strategies exist to reduce your tax liability. However, tax credits and deductions are probably the two most well-liked ones. Despite their apparent similarity, these are actually two quite distinct systems. A tax deduction reduces your taxable income for the year, whereas a tax credit reduces the amount of taxes you owe dollar for dollar. However, you can save some money with both.

What is Tax Deduction?

Investing in instruments that can immediately reduce someone's taxable income is known as a tax deduction. Investments in mutual funds, life and health insurance, tax-saving fixed deposits, and National Savings Certificates are a few instances of these deductions. The IT Act of 1961 contains definitions for each of the instruments that offer these deductions. There is a 1.5 lakh rupee cap on these deductions, though. In other words, a person can lower their taxable income by investing up to Rs. 1.5 lakhs. Any income over that threshold will be subject to taxation in accordance with the relevant slabs.

The following sections determine the tax deductions:

• The IT Act's Section 80C offers tax advantages on financial products like fixed deposits and life insurance.
• The section 80CCC addresses the deductions for investments made in pension schemes.
• Section 80D is the provision that permits tax deductions for contributions made toward health insurance plans.

What is Tax Credits?

In essence, tax credits are reimbursements that the government may grant to an individual in the event of exceptional circumstances. The following are the tax credits offered in India:

• If income was earned outside the nation and taxes were paid on it in India, a tax credit for the foreign taxes paid can be claimed.
• A tax rebate of Rs. 2,000 is available to anyone who is required to pay taxes but whose annual income is less than Rs. 5 lakhs.
• Over 65-year-old citizens are eligible for a tax credit of up to Rs. 20,000.
• Individuals with disabilities who fall within a specific income range are also eligible to apply for tax credits.

Certain tax credits are non-refundable, even though claiming them could increase your refund. This implies that any remaining funds cannot be utilized to boost the amount of your tax refund if the credit lowers your tax burden to a negative amount. Your refund check won't include the additional $100 if, for example, you only owe $1,400 in taxes but get a $1,500 tax credit.

Key Difference between Tax Deduction and Tax Credits

Although both tax credits and deductions help lower the amount of tax owed, there are distinctions between them. Some key distinctions are as follows:

• The primary distinction between a tax credit and a tax deduction is that the former lowers the amount of tax actually owing to the government, while the latter lowers the amount of income that is eligible for tax computation.
• The second distinction between the two is that, after following the application of tax deductions, a tax credit is applied to the amount of tax due. For instance, a guy earning 4.2 lakhs per year invests in insurance in a way that qualifies him for a tax benefit. His tax obligation is estimated to be around Rs. 8,000 after these deductions have been taken into consideration. Now that his annual income is less than Rs. 5 lakh, he qualifies for a Rs. 2,000 tax credit. This indicates that Rs. 6,000 is the amount of final tax owed by him. This example highlights yet another distinction between the two.
• A tax credit is awarded to individuals based on their eligibility for the credit. Therefore, it is applied regardless of any investments made. Nonetheless, the taxable income will not decrease, and no tax deductions will be applied to the earnings if the individual makes no investments during the year.
• Since tax credits immediately lower your tax liability, they are typically regarded as preferable to tax deductions. Your marginal tax bracket determines how a tax deduction affects your taxable income. For instance, a $1,000 deduction would only lower your taxable income by $100 if you were in the 10% tax rate (0.10 x $1,000 = $100). Nevertheless, if the same expenses qualify for both a tax credit and a deduction, calculating the difference will help you decide which will save you the most money come tax season.
• Tax Credit is available following the deductions. However, tax deductions are allowed prior to the use of tax credits.

Difference Table

Conclusion

Although they do it in different ways, tax credits and tax deductions both lower the overall amount of taxes you will pay. A tax deduction lowers your taxable income, which results in a little smaller tax bill, whereas a tax credit reduces the amount you owe dollar for dollar. If you're unsure about tax benefits you may qualify for, consider consulting a financial advisor or other tax expert.