Key Points

• Tax credits are a type of tax incentive that directly reduce the amount of tax owed, rather than reducing taxable income.
• There are several types of tax credits available, including those for education expenses, childcare expenses, renewable energy investments, and more.
• Tax credits can be refundable or non-refundable. Refundable tax credits can result in a refund even if the tax owed is less than the credit amount, while non-refundable credits can only be used to reduce the amount of tax owed.
• Eligibility for tax credits varies depending on the specific credit, but generally requires meeting certain criteria or making certain investments or expenses.

Introduction

There are many ways to decrease your tax bill, every year, and one of the most valuable options is to use a tax credit. Unfortunately, we can’t just decide to use them because they’re not always available. Only certain types are available for certain people and, the IRS has requirements for certain filings in order for a credit to potentially apply and in doing so, help you pay less. In this article, you’ll learn more the definition of “tax credit”, what the IRS requirements are to receive the credit, and how best to leverage them. If this is what you’re looking for, keep reading.

What is the Definition of “Tax Credit”?

A tax credit is defined as a dollar-for-dollar reduction in the amount of taxes owed by an individual or business. For example, if you owe the IRS $5,000 in taxes and have a $5,000 tax credit, the credit will cancel out the whole tax bill. Tax credits can even be used to offset the costs of taxes paid on income, sales, property, and other taxes.

There are two types of tax credits. All tax credits are either refundable and non-refundable.

Refundable tax credits can be used to reduce the amount of taxes owed and may be refunded if the credit exceeds the amount of taxes owed. 

Non-refundable tax credits can only be used to reduce the amount of taxes owed and will not be refunded if the credit exceeds the amount of taxes owed.

How Tax Credits Reduce Your Taxes

When you hear the term “tax credit,” you might think it has something to do with getting money back from the government. But a tax credit is actually an amount of money that you can subtract from the taxes you owe. So if you owe $1,000 in taxes and you have a $100 tax credit, you would only owe $900.

How is a tax liability calculated?

A tax liability is the amount of money that a person or company owes to the government in taxes. The tax liability is calculated by taking into account the individual’s or company’s income, expenses, deductions, and credits and finding their taxable income (what you arrive at after either taking the standard deduction or itemizing your deductible expenses) and applying the appropriate marginal income tax brackets to it.

How Do Tax Credits Work?

A tax credit is a dollar-for-dollar reduction in the taxes you owe. For example, if you owe $1,000 in taxes and you have a $1,000 tax credit, your tax bill is reduced to zero.

There are two types of tax credits. All tax credits are either refundable and non-refundable. A refundable tax credit can mean you’ll get a refund even if you owe no taxes at all, meaning you’re getting a handout which is nice if times are tough. A non-refundable tax credit can reduce your taxes but only until your tax bill is $0 (no one gets handouts from a non-refundable tax credit).

To qualify for a tax credit, you must meet certain criteria set by the government. For example, there are income limits for some credits, and some credits are only available to certain groups such as seniors or veterans.

If you think you might be eligible for a tax credit, be sure to check with the IRS or a tax professional to see if you qualify.

What Qualifies for a Tax Credit?

To qualify for a tax credit, you must meet certain criteria set forth by the Internal Revenue Service (IRS). For example, to claim the earned income tax credit, you must have earned income from employment or self-employment during the year. To claim the child tax credit, you must have a qualifying child who meets certain age, relationship, and residency requirements.

Education credits are available for taxpayers who are paying tuition and other eligible expenses for themselves or a dependent. The American Opportunity Tax Credit and Lifetime Learning Credit are two examples of education credits that may be available to taxpayers. To qualify for either of these credits, taxpayers must meet certain coursework requirements and other eligibility criteria.

Adoption tax credits are available to taxpayers who adopt a child. To qualify for this credit, taxpayers must incur eligible adoption expenses such as attorney’s fees, court costs, and travel expenses. Renewable energy tax credits are available for taxpayers who install solar panels or wind turbines on their property. To qualify for this credit, taxpayers must meet certain installation requirements set forth by the IRS.

Different Types of Tax Credits and Examples of Tax Credits

There are many different types of tax credits that can save you money on your taxes. Some tax credits are available for people with low incomes, while others are available for students or seniors. The most common tax credits include the following:

The Earned Income Tax Credit (EITC): This tax credit is available to low- and moderate-income earners. To qualify, you must have earned income from working (including self-employment) and meet other requirements. The EITC can reduce your federal income tax bill by up to $6,143.

The Child and Dependent Care Tax Credit (CDCTC): This tax credit is available to parents and caregivers who pay for child care so they can work or look for work. To qualify, you must have earned income from working (including self-employment) and meet other requirements. The CDCTC can reduce your federal income tax bill by up to $3,000 per child.

The American Opportunity Tax Credit (AOTC): This tax credit is available to undergraduate and graduate students who are enrolled at least half-time in a degree program. To qualify, you must have earned income from working (including self-employment) and meet other requirements. The AOTC can reduce your federal income tax bill by up to $2,500 per student.

The Lifetime Learning Credit (LLC): This tax credit is available to undergraduate, graduate, and professional degree students who are enrolled in eligible

How to Claim a Tax Credit

To claim a tax credit, you must file a tax return for the year in which you incur the expense. For example, if you made energy-efficient home improvements in 2020, you would claim the credit on your 2020 tax return.

Most tax credits have specific requirements that must be met in order to qualify. For example, the energy-efficiency credit mentioned above is only available for improvements made to existing homes, not new construction. There may also be income limits in place for certain credits.

If you think you might be eligible for a particular credit, it’s important to do your research and consult with a tax professional to make sure you meet all the requirements before claiming it on your return.

Comparing Credits To Deductions

Like we’ve mentioned, a tax credit is a dollar-for-dollar reduction in the tax you owe. A deduction, on the other hand, reduces your taxable income which in turn lowers your tax bill because taxes are progressive in the United States (meaning the more you earn, the higher the tax rate you’ll pay).

Both credits and deductions can reduce your tax bill, but they work in different ways. A deduction lowers your taxable income, which is then taxed at your marginal tax rate. A credit, on the other hand, is a dollar-for-dollar reduction of your tax bill.

So, which is better? It depends. If you’re in a high tax bracket, a deduction will save you more money than a credit because it lowers the amount of income that’s subject to taxation. But if you’re in a lower tax bracket, a credit will save you more money because it’s a dollar-for-dollar reduction of your tax bill.

There are also some credits that are nonrefundable, which means they can only reduce your tax bill to zero. And there are some that are refundable, which means they can actually give you a refund even if you don’t owe any taxes. So, when comparing credits to deductions, it’s important to keep all of this in mind.

Conclusion

A tax credit is a dollar-for-dollar reduction in the amount of taxes you owe. Tax credits are available for a variety of expenses and activities, including adopting a child, being an eligible student, being over the age of 65, and more. There are also tax credits available for energy-saving home improvements, and for installing renewable energy sources like solar panels or wind turbines. If you think you might be eligible for a tax credit, be sure to do your research so that you can take advantage of all the savings opportunities available to you.