Thomas: The fun part about tax deductions is that we save money on taxes! When I first learned about deductions, I was so confused about the difference between a deduction and a credit. I thought a $500 tax deduction meant I paid $500 less in taxes. But that’s not quite right.

So, Tom, what’s the difference between a tax deduction and a tax credit?

Tom: What you described—subtracting $500 directly from the taxes you owe—is a tax credit. If you owe more than $500 in taxes, a $500 credit reduces that amount directly. A deduction, however, lowers your taxable income. It’s calculated as gross income minus deductions, which gives you your taxable income.

Thomas: So, if I earn $10,000 and have $5,000 in deductions, I only pay taxes on the remaining $5,000. Right?

Tom: Exactly.