What is a tax credit?

A tax credit is indeed an amount that taxpayers can subtract directly from the taxes they owe. This means that if you have a tax liability of $1,000 and you qualify for a tax credit of $200, your actual tax payment would reduce to $800. Tax credits are beneficial because they provide a dollar-for-dollar reduction in tax liability, which can significantly lower the amount of tax owed by an individual or business.

In contrast, simply decreasing taxable income, as described in the first option, refers to deductions, which lower taxable income but not direct liability. The third option about a reduction in the tax rate applied relates to tax brackets or rates rather than a straightforward credit on owed tax. The fourth option about increased exemptions affects the tax situation by reducing the amount of income that is subject to tax but does not provide the same immediate financial relief as a tax credit does. Thus, the nature of a tax credit distinctly allows for direct reduction of tax payable, highlighting its importance and effectiveness for taxpayers.