What's the difference between a tax deduction and a tax credit?

The difference comes down to when and how they reduce your tax burden:

A tax deduction lowers the amount of your income that is subject to tax.

• How it works: If you earn $50,000 and have a $2,000 deduction, you are taxed as if you earned $48,000.
• The benefit: The actual savings depend on your tax bracket. If you are in the 20% tax bracket, a $2,000 deduction saves you $400 in taxes.

A tax credit provides a dollar-for-dollar reduction of the actual tax you owe.

• How it works: If you owe $5,000 in taxes and have a $2,000 tax credit, your bill is reduced directly to $3,000.
• The benefit: A credit is generally more valuable than a deduction because it doesn't depend on your tax bracket; it reduces your bill by the full face value of the credit.

In short: A deduction reduces the income you are taxed on, while a credit reduces the final tax bill you have to pay.