While deductions and credits can both reduce the amount of taxes you pay, they work in different ways.
Deductions are amounts that can reduce your taxable income which is used to calculate how much tax you owe. For example, if you made $30,000 and were able to claim $12,000 in deductions then your taxable income would be $18,000 ($30,000 - $12,000) and your tax would be calculated on that $18,000.
Credits do not reduce your taxable income but instead they directly reduce the amount of taxes you owe. For example, if you owe $1,000 in taxes and you qualify for a $200 credit then you would only need to pay $800 in taxes. Credits can be either refundable or non-refundable, depending on the credit.
- Non-refundable credits can reduce your tax liability but not more than the total amount of taxes you owe for the year.
- Refundable credits reduce your tax liability and any excess can be refunded to you, even if you don’t owe taxes this year or wouldn’t be receiving a refund otherwise.