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Everything That You Need To Learn About Tax Credits

Many of us know that tax deductions can help reduce the amount we owe the IRS. But did you know that tax credits frequently carry a bigger punch in terms of lowering your tax bill? Numerous tax credits are available to taxpayers of different ages and situations, particularly those with low or middle incomes. Let’s start with what is a tax credit and how does it work?

What Is A Tax Credit?

A tax credit is a monetary amount taxpayers can deduct from their tax liability. Tax credits, unlike deductions, reduce the amount of tax owing rather than the amount of taxable income. The credit’s nature determines a tax credit’s value; many tax credits are only available to individuals or businesses in specific localities, classifications, or industries. 

State and federal governments may grant tax credits to promote certain behaviors that help the economy, environment, or anything else that the government feels significant. For instance, a tax credit is available that rewards individuals for installing solar panels for personal use. Several other tax credits help reduce the costs of kids’ education and adoption.  

Tax Credits Vs. Tax Deductions: Major Differences

Tax credits and deductions bring down the amount of money you pay in taxes. Tax credits provide you a dollar-for-dollar refund on any taxes you owe. If you owe $6,000 in taxes but qualify for $3,000 in tax credits, your total tax amount will be $3,000.

On the other hand, tax deductions reduce the taxable amount of your income. As an example, if you make $50,000 per year and have $8,000 in deductions, your taxable income is $42,000. In other words, if you’re in the 24% tax rate, a $10,000 deduction saves you $2,400 in taxes.

Types Of Tax Credits

In general, the government provides tax credits to incentivize positive actions such as higher education or homeownership. Lower-income individuals are also eligible for credits, so if your income fell in 2020, you may qualify for certain credits for the first time.

However, not all tax credits are created equal. Non-refundable, refundable, and partially refundable are the three primary types:

Nonrefundable Tax Credits

You can only use a nonrefundable tax credit to reduce your tax liability to zero. If you owe $3,000 in taxes but qualify for $4,000 in tax credits, your tax bill will be zero, but you will not receive a $1,000 refund.

Refundable Tax Credits

As the term suggests, you’ll get a refund if your refundable tax credits exceed your tax liability. As we read in the previous example, a person who received a $4,000 refundable tax credit would also receive a $1,000 refund from the IRS.

Partially Refundable Tax Credits

You can use the entire amount of a partially refundable credit to reduce your tax liability to zero. Following that, you’ll be entitled to a refund based on a proportion of the balance due. The American opportunity tax credit, for example, is utilized for higher education expenses and allows you to take 40% of the credit amount left after your tax due has been reduced to zero.

Tax credits are usually divided into groups. Find out the list of the most popular and widely utilized credits below to determine whether you qualify. You can also visit the IRS website for a complete list of credits and deductions. Moreover, bear in mind that many states offer tax credits that you can use when filing your state’s return.

Family And Dependent Tax Credits

The Internal Revenue Service offers multiple tax credits to reduce the tax impact of working individuals and families, with or without kids. Furthermore, if your earnings took a hit in 2020, you might qualify for the Earned Income Tax Credit or EITC. Let us find out more about family tax credits

Earned Income Tax Credit

The EITC is a tax credit meant to help low and middle-income people. The credit is available to single earners with incomes ranging from $538 to $15,820 for the 2020 tax year. The EITC can be defined as a credit that can be refunded. 

For taxpayers with children, the EITC income limit is increased. A married couple with three children, for example, can earn up to $56,844 and still qualify for the benefit. There’s an old joke about kids being worth their weight in gold on tax day, 15th April. The following credits demonstrate how your kids can help you save money on your taxes.

Child And Dependent Care Credit

With child tax credits, parents can claim up to $2,000 in the child tax credit for each citizen kid under the age of 17. The credit begins to phase away for married couples earning more than $400,000. The credit is refundable, and after the tax obligation is zero, up to $1,400 of the remaining credit will be issued as a refund.

Adoption Credit

This nonrefundable credit can assist reduce the high costs of adoption by up to $14,300 per qualified kid.

Credit For Disabled Or Elderly

This credit may be available to taxpayers who are 65 or older or who have retired early due to disability and are living on a fixed income.

Education Tax Credits

You’re probably aware of higher education’s rising costs. On the other hand, a college degree is frequently required to enter high-paying areas or make a professional change. Thankfully, there are tax credits available to aid with the cost of tuition.

Lifetime Learning Credit

It is a nonrefundable tax credit of up to $2,000 that can be used to defray the cost of undergraduate, graduate, or professional degree courses. You can claim the credit for an indefinite number of years provided you meet the requirements. After a particular income level, you will no longer be eligible for the credit.

American Opportunity Tax Credit

It is available to students in their first four years of higher education and can be worth up to $2,500 each year. Once your tax bill reaches zero, the credit is refundable up to 40% of the remaining amount, or $1,000. 

Business Tax Benefits can be the perfect place if you wish to clear all your queries related to taxes. You can learn lots of things about the CARES Act and Employee Retention Tax Credit on our website. Moreover, our tax experts ensure that you are maximizing the credits and deductions as per your situation. 

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