Keith Mack
Tax credits are a great way to lower your tax bill and potentially increase your refund. They are offered by both federal and state governments to incentivize certain actions, such as purchasing an electric vehicle, or to offset the cost of certain expenses like raising a child. Tax credits differ from tax deductions in that they directly reduce the amount of tax you owe, whereas deductions reduce your taxable income. There are three types of tax credits: refundable, partially refundable, and nonrefundable. Refundable tax credits are the most beneficial as they are paid out in full and can even result in a refund if your tax bill is less than the credit amount. The most popular refundable tax credit is the Earned Income Tax Credit (EITC) for low- to moderate-income taxpayers. Other common tax credits include the Child Tax Credit, the American Opportunity Tax Credit for education expenses, and clean energy credits. To see which credits you may be able to claim, you can use the Interactive Tax Assistant tool on the IRS website.
| Characteristics | Values |
|---|---|
| Definition | A tax credit is a dollar-for-dollar amount taxpayers claim on their tax return to reduce the income tax they owe. |
| Types | Tax credits can be refundable, non-refundable, or partially refundable. |
| Examples | Earned Income Tax Credit (EITC), Child Tax Credit, Premium Tax Credit, American Opportunity Tax Credit, Clean Energy Credits |
| Eligibility | Eligibility criteria vary depending on the type of tax credit. For example, the EITC is for low- to moderate-income taxpayers with a certain number of family members, while the Child Tax Credit requires the child to be a US citizen under 17 with a Social Security number. |
| Benefits | Tax credits can reduce tax liability, increase refunds, and incentivize specific behaviors such as purchasing an electric vehicle or adopting a child. |
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What You'll Learn
The Child Tax Credit
- The child must be a US citizen under the age of 17 with a valid Social Security number for employment in the United States.
- The child must be claimed as a dependent on the taxpayer's tax return.
- Qualifying children may include foster children or extended family members if they meet other criteria.
- The child must not provide more than half of their own financial support for the tax year.
- The child must have lived with the taxpayer for more than half of the tax year.
The CTC has a significant impact on the economic well-being of low-income families with children. The amount of the credit varies depending on the age of the qualifying child and the income of the taxpayer. For the 2021 tax year, the American Rescue Plan increased the CTC to $3,600 for children under the age of 6 and $3,000 for children aged 6 to 17. The credit is non-refundable, meaning it reduces the taxpayer's tax liability but does not result in a refund if it exceeds taxes owed. However, in some cases, the Internal Revenue Service (IRS) may issue advance payments of up to half of the estimated CTC amount.
To claim the Child Tax Credit, parents and guardians need to file their taxes and include their children and other dependents on Form 1040, U.S. Individual Income Tax Return, along with Schedule 8812, Credits for Qualifying Children and Other Dependents. It is important to note that the eligibility criteria and credit amounts may change from year to year, so taxpayers should carefully review the current tax credits and consult official sources for the most up-to-date information.
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The Earned Income Tax Credit
The amount of the EITC credit is based on a percentage of earnings, starting from the first dollar of income until it reaches its maximum. The maximum credit is paid until earnings reach a specified level, after which the credit gradually decreases with each additional dollar of income until no credit is available. The credit amount may vary depending on factors such as the number of children, dependents, disability status, or other criteria.
The EITC is particularly beneficial for low- and moderate-income working parents who claim a qualifying child based on relationship, age, residency, and tax filing status requirements. Families with more children may be eligible for larger credits. However, the EITC also provides support to workers without qualifying children, often referred to as "childless workers," although the amount of support is significantly smaller.
To determine eligibility and calculate the exact amount of the EITC, taxpayers can use the EITC Assistant provided by the Internal Revenue Service (IRS). It is important to note that claiming the EITC may have an impact on other government benefits, especially for military personnel and clergy. Additionally, the IRS is required by law to delay refunds for taxpayers claiming the EITC until mid-February to allow for the verification of claims and protect revenue.
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The American Opportunity Tax Credit
To be eligible for the AOTC, a student must not have completed the first four years of higher education at the beginning of the tax year and must be enrolled in at least one academic semester during the applicable tax year. They must also maintain at least half-time status in a program leading to a degree or other recognised educational credential. In addition, the student must not have a felony drug conviction at the end of the tax year.
To claim the AOTC, the student or their parents must complete Form 8863 and attach it to their tax return. They must also have received Form 1098-T, Tuition Statement, from an eligible educational institution. This can include any accredited public, nonprofit, or private college, university, vocational school, or other post-secondary educational institution.
The amount of the AOTC is 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000, up to a maximum of $2,500 per eligible student per year. If the credit reduces the taxpayer's liability to zero, they can receive a refund of up to $1,000 (40%) of the remaining credit. The AOTC begins to phase out for single taxpayers with an adjusted gross income of $80,000 to $90,000 and for joint filers with an adjusted gross income of $160,000 to $180,000.
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The Premium Tax Credit
To qualify for the PTC, your health insurance situation, tax situation, immigration status, and income need to meet certain criteria. You must have an income above the federal poverty line to be eligible for the PTC. Traditionally, your income also needed to be below 400% of the federal poverty line to qualify for the PTC, but Congress has temporarily eliminated this rule for tax years 2021 through 2025 and substituted it with a slightly more complicated income-based eligibility requirement. You might not qualify for the PTC if other health insurance options are available to you, such as employer-sponsored insurance or another government program such as Medicare.
If you qualify for the PTC, you can choose between receiving it as a tax credit when you file your return or paying it to your insurer in exchange for lower monthly premiums throughout the year. You can also choose to receive part of it as a credit and the rest in the form of lower premiums. For tax years other than 2020, if you plan to claim the PTC, you must file a federal income tax return and attach Form 8962, Premium Tax Credit (PTC), to your return.
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Clean energy credits
To qualify for the credit, the property must be located in the United States and used as the taxpayer's principal residence. This includes renters who make eligible improvements, but excludes landlords or property owners who do not live in the home. For fuel cell properties, the credit is limited to $500 for each half kilowatt of capacity, with a combined credit limit of $1,667 for multiple residents.
Qualified expenses include the costs of new clean energy property, such as solar roofing tiles and solar shingles, as well as labor costs for installation. Public utility subsidies, rebates, and certain state energy efficiency incentives are subtracted from these qualified expenses.
Homeowners can maximize their credits by planning their upgrades and spreading their energy efficiency improvements over several years. For example, they can first optimize their attic insulation to reduce air leaks and then claim 30% of the product cost of insulation, up to $1,200.
By investing in renewable energy and making energy-saving improvements, individuals can not only reduce their carbon footprint but also take advantage of the Residential Clean Energy Credit to lower their tax burden.
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Frequently asked questions
A tax credit is a benefit that lowers your taxes owed by the amount of the credit.
Tax credits can be refundable, partially refundable, or nonrefundable. Refundable tax credits are the most beneficial credits because they are paid out in full.
Some popular tax credits include the Earned Income Tax Credit (EITC), Child Tax Credit, and American Opportunity Tax Credit. The EITC is for low- to moderate-income taxpayers, while the Child Tax Credit provides a credit for each dependent child. The American Opportunity Tax Credit is for qualified education expenses for the first four years of higher education.
You can use the Interactive Tax Assistant on IRS.gov to find out which tax credits you may be able to claim. You can also use tax software or seek advice from a tax expert.
