Which of the following statements correctly distinguishes between a tax deduction and a tax credit in the context of personal income taxes?

• A. A tax deduction reduces tax liability dollar for dollar, while a tax credit reduces taxable income.
• B. A tax deduction reduces taxable income, while a tax credit reduces tax liability dollar for dollar.
• C. Both a tax deduction and a tax credit reduce tax liability dollar for dollar.
• D. Both a tax deduction and a tax credit reduce taxable income.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the definitions of tax deduction and tax credit. A tax deduction reduces the amount of income that is subject to tax, effectively lowering taxable income.
2. Step 2: Recognize that a tax credit directly reduces the amount of tax owed, dollar for dollar, after taxable income has been determined and tax rates applied.
3. Step 3: Compare the effects: a tax deduction lowers taxable income, which then reduces tax liability based on the marginal tax rate, while a tax credit subtracts directly from the tax liability itself.
4. Step 4: Evaluate the given statements by matching them to these definitions. The correct distinction is that a tax deduction reduces taxable income, and a tax credit reduces tax liability dollar for dollar.
5. Step 5: Conclude that the statement 'A tax deduction reduces taxable income, while a tax credit reduces tax liability dollar for dollar' correctly distinguishes between the two concepts.