Which of the following statements is true regarding tax credits?

Tax credits are designed to reduce the overall tax liability owed by a taxpayer, and they do so on a dollar-for-dollar basis. This means that if a taxpayer qualifies for a tax credit worth a certain amount, that amount is directly subtracted from their total tax bill. For example, if an individual has a tax liability of $5,000 and qualifies for a $1,000 tax credit, their tax liability will be reduced to $4,000. This characteristic distinguishes tax credits from deductions, which reduce taxable income rather than the tax owed.

In contrast, deductions lower the amount of income that is subject to taxation but do not provide as direct a benefit as tax credits. Additionally, tax credits are not limited to earned income, as they can be available for various qualifying expenses or situations, such as education costs or energy-efficient home improvements. While some credits may have maximum limits, this statement does not universally apply to all tax credits, as there are also credits that do not impose such limits.