As its name suggests, tax deductions tend to decrease your taxable income because these are items deducted before your final income is determined. The first of tax deductions is the above-the-line deduction which is used to find your adjusted gross income (total income less deductions equals the adjusted gross income).
From the adjusted gross income, another group of tax deductions are deducted. The Form 1040 gives the guide to these deductions. You may choose between standard deductions or itemized deductions. Using Schedule A, you may add up all your itemized deductions and find out if it exceeds your standard deductions. You may choose the larger of your itemized deductions and standard deductions. This, again, is deducted from the adjusted gross income.
The second round of deductions results in the taxable income. It should be noted that your taxable income should be thousands less than your actual income. Now, you are ready to determine how much you owe in taxes using the tax table.
Once you have figured out how much tax you should pay, deduct the taxes you have already paid through your quarterly taxes and those withheld from your salaries. This amount is called tax credit. Tax credit automatically reduce the taxes you owe. For instance, based on the tax table, you owe taxes in the amount of $1,100. You have accumulated $500 in tax credits. Then, by April 15, you will have to pay only $600. If your tax credits exceed the taxes you are supposed to pay, you get a tax refund.
Which of these two matters? Tax credits make a huge difference. While tax deductions are helpful, they might not be enough to significantly reduce your taxes. A tax deduction worth $100 will not create a great impact as much as $100 in tax credits.