Which of the following best defines a tax credit?

A tax credit is best defined as an amount subtracted from the total taxes owed. This means that if you qualify for a tax credit, the amount of the credit directly reduces your tax liability on a dollar-for-dollar basis. For example, if you owe $1,000 in taxes and you have a tax credit of $200, your total tax liability is reduced to $800. This makes tax credits a more favorable tax benefit compared to deductions, which reduce taxable income rather than tax owed.

Tax credits can be particularly valuable because they directly lower the amount of tax you need to pay, making them a strategic tool in tax planning. Unlike some other options provided, tax credits do not serve to merely reduce taxable income or represent income not subject to tax; instead, they specifically lower the taxes payable.

Tax credits can be either nonrefundable, meaning they can only reduce tax liability to zero, or refundable, where excess credits can be refunded to the taxpayer. Understanding how tax credits function can significantly influence tax strategies for individuals and businesses alike.