deductions and tax credits - Which is better? Income Deductions reduce income. Tax Credits reduce tax liability Between the income and tax credits, tax credits are better. Here’s why: $500 deduction will only reduce your income by $500, it may not reduce your tax liability. $500 tax credit will reduce your tax liability by $500 Form 1040 Deductions and Itemized deductions phase out at higher income levels. Itemized deductions are tied to your Adjusted Gross Income Charitable contributions - Deduct up to 50% Medical Deduction - 7.5% and 10% of AGI requirement before yuo can deduct Miscellaneous Deduction - 2% AGI limitations before you can deduct Some credits are limited - energy credits, foreign tax credit alternative energy credit. They are limited in the amount of the tax credit or the amount of units produced (alternative energy vehicles) Some itemized deductions require an appraisals like art, vehicles and properties. Whether it’s itemized deductions, income deductions, or tax credits, you can reduce your taxable income or tax liability.