Tax Deduction
A tax deduction, such as contributions to a Traditional IRA or 401(k), reduces your adjusted gross income How much that deduction is worth to you depends on your marginal income tax rate.
If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year. If you are in the 10% bracket, a $1000 tax deduction means you’ll pay $100 less tax that year. If you have a simple tax situation, with little income outside of your regular job, this translates to a larger tax refund.
Common tax deductions are the two mentioned before, Traditional IRA and 401(k) contributions, as well as mortgage loan interest, student loan interest, and charitable donations.
Tax Credits
A tax credit is a dollar for dollar reduction in your income taxes. If you have a $1000 tax credit, you will pay $1000 less tax that year regardless of your tax bracket. A good example is the $1000 child tax credit. If your child applies and you don’t exceed the income limits, you get $1000 for each dependent child you claim on your tax return.
Common tax credits are the child tax credit, Hope Scholarship and Lifetime Learning Credits (education related), retiresvings credit and adoption credit.