Tax glossary

Tax Credit

Tax Credit — what it means, how it works, and a real example, explained without the jargon.

What is Tax Credit?

A tax credit reduces your tax bill dollar for dollar. It's the most powerful kind of tax break there is.

How it works

Credits come off your calculated tax directly, not your income. A $2,000 credit erases $2,000 of tax, period — regardless of your bracket. Some are nonrefundable (they can zero out your tax but not go below it) and some are refundable (they can pay you the excess).

A quick example

A $2,000 Child Tax Credit cuts a $5,000 tax bill to $3,000. Compare that to a $2,000 deduction, which in the 22% bracket saves only $440.

What people get wrong

When you're choosing between a credit and a deduction of the same size, the credit almost always wins. Deductions save you your bracket rate; credits save you the whole amount.

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Frequently asked questions

What does Tax Credit mean?

A tax credit reduces your tax bill dollar for dollar. It's the most powerful kind of tax break there is.

How does Tax Credit work?

Credits come off your calculated tax directly, not your income. A $2,000 credit erases $2,000 of tax, period — regardless of your bracket. Some are nonrefundable (they can zero out your tax but not go below it) and some are refundable (they can pay you the excess).

What's the most common mistake with tax credit?

When you're choosing between a credit and a deduction of the same size, the credit almost always wins. Deductions save you your bracket rate; credits save you the whole amount.