A tax credit is a reduction in a taxpayer’s tax liability. Typically, tax credits are either refundable or non-refundable. Consumers can benefit from tax credits, enjoying a reduction in the amount of taxes they owe when filing either state or federal taxes. These credits can help people save money come tax season and may even prevent them from having to take out an additional form of funding, like a payday loan, in order to pay their tax liability.
How Tax Credits Work
Claiming tax credits isn’t as complicated as you might think. All you need to do is make sure you meet the proper qualification criteria, fill out the proper forms, submit them with your tax return, and you’re done! You can also check with a tax or financial advisor to ensure you meet the requirements and correctly fill out the appropriate forms.
Different Types of Tax Credits
There are generally three main types of tax credits; nonrefundable, refundable, and partially refundable. Below is more information on the different types of tax credits!
Nonrefundable Tax Credit
A non-refundable tax credit is a credit that is directly deducted from a consumer’s tax bill until the amount reaches $0. If the tax credit is worth more than the consumer’s tax liability, they will not receive a tax refund for the remaining amount. Below is more information on some of the most common types of non-refundable tax credits.
Child Tax Credit
The Child Tax Credit (CTC) is for individuals with a gross income of no more than $200,000 and couples with a joint gross income of no more than $400,000. For a child to qualify for the Child Tax Credit, they must have a social security number that is valid for employment in the U.S. as well as meet the following requirements:
- Be 17 years or younger.
- Be your direct offspring, stepchild, eligible foster child, dependent brother, sister, step-sibling, half-sibling, or a direct descendant of one of those people (a niece or nephew, for example).
- Covers no more than half of their own yearly financial support.
- Has lived with you for more than half of the tax year.
- Be claimed as a dependent on your tax return.
- Not file a joint tax return. If they do, the IRS says it must only be to “claim a refund of withheld income or estimated tax paid.”
- Be a U.S. citizen, a U.S. national, or U.S. resident alien.
The adoption tax credit may cover the following expenses when adopting a child:
- Fees that are required for adoption, within reason.
- Fees related to paying an adoption attorney or court costs.
- Qualifying traveling expenses. This may include money spent on meals and lodging while away from home for adoption purposes.
- Other qualifying expenses that are directly related to the legal adoption process.
Lifetime Learning Credit
The Lifetime Learning Credit (LLC) is designated for qualifying expenses for up to $2,000 related to education costs. Undergraduate, graduate, and professional degree students may be able to qualify for the Lifetime Learning Credit. There is also no limit as to how many times a consumer may claim this credit.
Consumers must meet the following requirements in order to qualify for the Lifetime Learning Credit:
- You, a dependent, or a third party are paying qualified education expenses.
- You, a dependent, or a third party are enrolled in an eligible educational institution.
- The eligible student is you, a spouse, or a dependent listed on your tax return.
Residential Energy Credit
The Residential Energy Credit allows consumers to deduct costs equal to the associated percentage of the total cost of a qualified property. Generally, percentages work as follows:
- 30% for properties placed in service after 12/31/16 and before 1/1/20.
- 26% for properties placed in service after 12/31/19 and before 1/1/23.
- 22% for properties placed in service after 12/31/22 and before 1/1/24.
Qualifying properties that may qualify for the Residential Energy Credit are:
- Solar electric property.
- Solar water heaters.
- Geothermal heat pumps.
- Small wind turbines.
- Fuel cell property.
Work Opportunity Credit
The Work Opportunity Credit (WOTC) is a type of Federal tax credit designed for employers who hire and keep on people from designated targeted groups, often minorities, with a history of discrimination and other barriers in the workplace. The purpose of this tax credit is to encourage employers to hire more diversely.
Child and Dependent Care Credit
The Child and Dependent Care Credit is a tax credit of $3,000 for one qualifying individual or $6,000 for two qualifying individuals. This tax credit is meant to cover expenses needed for the well-being and protection of a child or dependent. Keep in mind that this tax credit is separate from the Child Tax Credit.
Other Dependents Credit
In addition to the Child Tax Credit and the Child and Dependent Care Credit, consumers may also claim other dependent tax credits in the amount of $500 for each dependent who meets the qualifying criteria. This tax credit is for dependents who:
- Are any age, even if they are 18 or older.
- Have a social security number or individual taxpayer identification number.
- Has parents or qualifying relatives who are supported by the taxpayer.
- Are living with the taxpayer and a dependent, but not directly related.
Retirement Savings Contributions Credit
The Retirement Savings Contributions Credit was designed to encourage people to save for their retirement. This tax credit can offset part of the first $2,000 that people contribute to their retirement account, 401k, or another account part of a workplace retirement program.
Mortgage Tax Credit Certificate
The Mortgage Tax Credit Certificate (MCC) was designed to help make mortgages more affordable and therefore encourage more consumers to become homeowners and purchase real estate. This tax credit may also encourage private lenders to approve more types of borrowers, including those who earn a low-to-moderate income, for mortgages.
Refundable Tax Credit
A refundable tax credit is money paid to the taxpayer in full, even if it is beyond their total amount of taxes due. For refundable tax credits, any excess is included with the taxpayer’s total refund. The most common type of refundable tax credit is most likely the Earned Income Tax Credit.
Earned Income Tax Credit
The earned income tax credit was designed for people who earn a low-to-moderate income and are taking care of children or dependents, are disabled, or who meet other eligibility criteria. Military members and clergy members should check with a tax advisor before claiming this credit, however, as it may alter some of their other government benefits.
Partially Refundable Tax Credit
When a tax credit is partially refundable, this means that the taxpayer may be able to receive all or a portion of the full tax credit if they meet the required eligibility requirements.
Tax Credit Eligibility Requirements
There are various factors that will determine whether a taxpayer is eligible for a tax credit or not. The most important factors are typically recurring income and filing status. Keep in mind that these are not the only eligibility criteria required to qualify for a tax credit. Other factors may include:
- Place of employment.
- Relationship status to various people.
Your total gross income will also affect what tax credits you may be eligible to receive. Some tax credits are only available to consumers who earn an income at or below a certain threshold. Funding amounts may also differ depending on income.
Your filing status will also affect the amount of tax credits you may be eligible for. For example, the child tax credit is available for individuals earning an income of $200,000 or less and for married couples earning a combined income of $400,000 or less. Furthermore, your relationship status with other people may also help determine tax credit qualifications. For example, consumers may utilize certain dependent tax credits if they are taking care of a person with a specific relationship to them. This means someone may be able to receive a tax credit if they are fully supporting their deceased sister’s child but not a close friend.
Guide for Claiming Tax Credits
If you want to take advantage of tax credits, you must claim them while filling out your tax return. If you are filing your taxes with an in-person advisor, tell them about your situation, and they should be able to tell you if you meet the qualification criteria for any number of tax credits. Or, for consumers filing their taxes electronically via tax filing software, the program should ask specific questions to determine whether they qualify for any available credits.
Limitations on Tax Credits
While there are helpful benefits taxpayers can enjoy when they utilize tax credits, there are also some limitations everyone should be aware of. Some limitations taxpayers may experience with some tax credits are:
- They may not fully eliminate tax liability.
- If a taxpayer meets some, but not all, of a tax credit’s qualification requirements, they may not receive the credit.
- Some tax credits have an expiration date.
- Some tax credits have limited availability.
Strategies for Tax Credits
Some strategies to utilize to make the most of any available tax credits are:
- Review All Possible Tax Credits – Before filing your taxes, take a look at the available credits. You may already qualify for a tax credit and not even know it!
- File On Time – Make sure you file your taxes on time to benefit the most from tax credits. If you wait, providing documents or proving you were previously qualified may be more difficult as time passes.
- Combine Tax Credits – By creating a financial plan and thoroughly reviewing your finances and qualification requirements, you may find that you are eligible for more than one tax credit. This may allow you to combine tax credits and receive even more of a reduction in your tax liability.
Top Tips for Tax Credits
Below are a few tips on how you can benefit from tax credits the next time you file your taxes!
- Keep Accurate Records – Streamline the process of claiming your tax credits by keeping thorough and accurate records. Instead of spending hours looking for documents or paying a fee to have them reproduced, being adamant about your personal record keeping may help make the process of filing your taxes and receiving tax credits infinitely easier.
- Stay Up To Date on Tax Laws – Tax laws and regulations may change over time or depending on what state you live in. Make sure you stay current with tax laws in your area to ensure you still qualify for a tax credit you may have received in the past or to see if you may now qualify for a tax credit you weren’t eligible for before.
- Get a Second Opinion – If you feel comfortable sharing your information, have a tax advisor, credit counselor, or other financial representative take a look at your taxes to see if you missed a tax credit (or a deduction) you may qualify for. It would be a shame to miss out on money just because you missed one small detail!
Where Can I Find Tax Credit Resources?
The best place to find additional resources about tax credits is directly from the Internal Revenue Service (IRS). Mainly, the purpose of the IRS is to make sure citizens properly complete their tax returns each year, to administer refunds to citizens who overpaid their taxes over the year, and to collect payments from citizens who owe the government money due to taxes. In order to make sure citizens successfully complete their tax returns, they have extensive resources available online.
FAQs: Tax Credits
Below are some frequently asked questions taxpayers may have regarding available tax credits.
What Are the Benefits of Tax Credits?
Taxpayers can benefit from tax credits by saving money and reducing their taxes owed, also called tax liability. Generally, consumers tend to favor refundable tax credits over non-refundable credits because they can usually financially benefit more if a tax credit is fully refundable. Increased refunds from tax credits also have the ability to stimulate economic growth, depending on how the taxpayer spends their refund.
What Is Taxable Income?
Taxable income is a portion of your income that is subject to tax by the IRS. There is a federal income tax that applies to all citizens, and some states have individual state income taxes as well.
While funding from a personal loan typically is not considered taxable income, other forms of income, like the money you earn from your job or from other assets, are usually subject to federal and possibly state taxes.
What Is Tax Liability?
Your tax liability simply refers to the amount of money you owe for a given tax year. For example, say you owed $500 for your federal income tax and $200 for state taxes; that would bring your total tax liability to $700.
What Is the Difference Between a Tax Credit and a Tax Deduction?
While both credits and deductions can help taxpayers save money, the way they operate is slightly different. A tax credit is a dollar-for-dollar reduction in the total amount of taxes a consumer owes. Tax deductions are a reduction in a consumer’s taxable income.
Bottom Line: Tax Credits
Tax credits are a dollar-for-dollar reduction of a consumer’s tax liability. In order to benefit from tax credits, taxpayers must meet specific qualification requirements that may differ depending on the tax credit, the taxpayer’s income, or state or residence. To make sure you are making the most out of available tax credits, you should focus on keeping thorough financial records, filing your taxes on time, and seeking professional help or advice when needed.
- Understanding Taxes – Module 8: Claiming Child Tax Credit
- Topic No. 607, Adoption Credit and Adoption Assistance Programs | Internal Revenue Service
- LLC – Lifetime Learning Credit
- Energy Incentives for Individuals: Residential Property Updated Questions and Answers | Internal Revenue Service
- Work Opportunity Tax Credit | Internal Revenue Service
- Child Tax Credit | Internal Revenue Service
- Topic No. 602, Child and Dependent Care Credit | Internal Revenue Service
- Understanding the Credit for Other Dependents | Internal Revenue Service.
- Retirement Savings Contributions Savers Credit | Internal Revenue Service
- Mortgage Tax Credit Certificate (MCC)
- Earned Income Tax Credit (EITC) | Internal Revenue Service