What does a tax credit refer to?

A tax credit is an amount subtracted directly from the tax owed, making it a powerful tool for taxpayers. Unlike tax deductions, which reduce the overall taxable income, a tax credit reduces the actual tax liability dollar-for-dollar. This means that if a taxpayer owes $1,000 in taxes and receives a $200 tax credit, their final tax bill would only be $800.

Tax credits can be particularly advantageous because they provide a more direct benefit compared to deductions. For instance, a deduction may lower the taxable income based on the individual's tax bracket, leading to a variable reduction in taxes owed, whereas a credit provides a definitive reduction in the tax bill.

This fundamental understanding of tax credits is crucial for tax planning, as they can lead to significant savings for individuals and businesses alike.