What is the key distinction between a tax credit and a tax deduction?

The key distinction between a tax credit and a tax deduction lies in how they affect a taxpayer's financial obligation to the government. A tax deduction reduces a taxpayer's overall taxable income, which in turn lowers the amount of income that is subject to taxation. For example, if an individual has a taxable income of $50,000 and claims a $1,000 tax deduction, their new taxable income becomes $49,000.

On the other hand, a tax credit directly reduces the amount of tax owed. A tax credit provides a dollar-for-dollar reduction on the tax bill. So if that same individual owes $5,000 in taxes and claims a $1,000 tax credit, their total tax liability reduces directly to $4,000.

Understanding this distinction is crucial because tax deductions can provide savings based on the taxpayer's marginal tax rate, while tax credits provide a more straightforward reduction of tax liability. Therefore, option C accurately summarizes this relationship by stating that tax deductions reduce taxable income, while tax credits reduce the tax due.