Remember that time you dug out the old jacket you hadn’t used in months from the closet and found a crumply $20 bill hiding inside one of the pockets? Makes you want to do a happy dance just thinking about it, right?
In the tax world, finding out if you qualify for a tax credit can feel a lot like finding that unexpected $20 bill—only much more valuable! Tax credits can magically shave hundreds, or even thousands, of dollars off your tax bill. Now that is worth busting a move or two!
Let’s take a closer look at what a tax credit is, how they work, and which ones you might be able to claim on your tax return this spring.
What Is a Tax Credit?
A tax credit reduces how much you pay in taxes by letting you subtract a certain amount of money directly from your tax bill. A $500 tax credit, for example, will save you $500 in taxes owed. The more tax credits you claim, the more money you get to keep in your pocket!
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What’s the point of having tax credits? The government sometimes uses taxes as a “stick” to try to discourage folks from certain behaviors or activities (think taxes on cigarettes). But Uncle Sam will also dangle a tax credit as a “carrot” to encourage certain behaviors and activities that might be beneficial for the economy, the environment or some other cause.
Tax credits are also a way to provide a tax break for low- and middle-income taxpayers who need it most.
What’s the Difference Between a Tax Deduction and a Tax Credit?
While tax deductions and tax credits both lower how much you’ll pay in taxes, they do so in different ways. Deductions lower your taxable income while tax credits lower how much you actually owe in taxes dollar for dollar.
Deductions lower your taxable income while tax credits lower how much you actually owe in taxes dollar for dollar.
How does all that work? Well, if you’re in the 22% tax bracket, a $1,000 tax deduction will cut $220 off your tax bill. That’s pretty good! But a $1,000 tax credit will actually save you $1,000 in taxes for the year. So, between deductions and credits, it’s pretty clear to see that tax credits are the more valuable of the two!
Refundable vs. Nonrefundable Tax Credits: How Do Tax Credits Work?
While tax credits are great, not all tax credits are created equal. That’s because a tax credit can either be refundable or nonrefundable.
You still subtract both types of tax credits from what you owe in taxes, but there’s a big difference if the credit is greater than the amount you owe. With a refundable tax credit, the difference is paid to you as a refund! But with a nonrefundable credit, you won’t get a refund—the best you could hope for is to reduce your tax bill to zero.
A tax credit can either be refundable or nonrefundable.
For example, let’s say you owe $500 in taxes this year. If you’re eligible for a $750 nonrefundable tax credit, your tax bill goes down to zero, which is great, but you wouldn’t receive the extra $250 as a refund. The amount that’s left over is basically lost.
But what if that $750 tax credit was a refundable tax credit? In that case, you’d end up with no tax bill and you also get a $250 check back from the IRS. Nice!
Unfortunately, most tax credits are nonrefundable (boo!) but there are still some refundable tax credits you might qualify for!
What Tax Credits Are Available for Taxpayers?
There are dozens of tax credits available for all kinds of taxpayers, from parents and low-income workers to students and Americans living overseas. Chances are there’s one or two you might be able to claim on your tax return!
Here’s a rundown on some of the most common tax credits you might be able to claim this year.
Earned Income Tax Credit
This is the Big Kahuna of tax credits! The EITC is a refundable credit designed to help out low- and middle-income workers, especially those with children. Depending on your income, your filing status, and how many children you have, the credit could save you anywhere from $529 to $6,557 on your taxes.1
Workers earning up to $54,884 during the 2019 tax year might be eligible for the EITC.2 And while this is the most popular credit out there, the IRS estimates that one out of five taxpayers who are eligible either don’t claim the benefit on their taxes or don’t file a tax return at all.3 Don’t make that mistake!
Child Tax Credit
Kids are awesome. Kids are also expensive. But thanks to the 2018 tax reform bill, families can claim up to $2,000 per qualified child with this tax credit (the income limits for this credit are $200,000 for single parents and $400,000 for married couples). And it’s a refundable credit, so if it’s worth more than what you owe in taxes, your family can receive up to $1,400 per child as a refund. Thanks, Junior!4
There are two major tax credits available for students. First, there’s the American Opportunity Credit. This credit is available only for students in their first four years of college and it’s worth up to $2,500 per student. Plus, it’s partially refundable, meaning you can receive up to $1,000 as a tax refund—even if you don’t owe anything in taxes!
If you’ve been in school longer than four years or you’re taking courses to advance your career, then the Lifetime Learning Credit is for you. Although this credit is nonrefundable, it can still cut your tax bill by up to $2,000.5 So stay in school, kids!
Retirement Savings Contributions Credit (Saver’s Credit)
This one’s for all you retirement savers out there! Also known as the Saver’s Credit, this nonrefundable credit helps low- and middle-income taxpayers who are saving for retirement. Depending on how much you make and what your tax filing status is, you can claim the credit for 50%, 20% or 10% of the first $2,000 you contribute to your retirement accounts, including 401(k)s and IRAs.
If you’re married filing jointly, your adjusted gross income has to be less than $64,000 in order to qualify for this credit (for singles, it’s $32,000 or less).6
Foreign Tax Credit
Just because you’re an American living overseas doesn’t mean you’re free from Uncle Sam’s grasp. But cheer up! To ease the pain of being taxed in two or more countries, the income taxes you’ve paid in another country can usually be claimed as a nonrefundable credit to lower your tax burden.7
Child and Dependent Care Credit
If you need to pay for child care so that you can go to work or if you’re caring for a spouse or parent who is unable to care for themselves, this credit can help you claim 20%–35% of up to $3,000 (or up to $6,000 of expenses for two or more dependents) of those costs.8
Elderly or Disabled Credit
Sometimes it pays to be a senior citizen. You get all kinds of discounts, free memberships and some pretty neat tax breaks! If you’re at least 65 years old or you’re retired with a permanent disability, you could knock $3,750–$7,500 off your tax bill with this nonrefundable tax credit.9
Get Your Taxes Done Right
Think you might qualify for one of these tax credits, but you’re not sure? You’re not alone! Unfortunately, millions of dollars in tax credits go unclaimed each year—that’s money that should be in your bank account instead of the government’s coffers!
If you need a tax advisor to help you with your taxes, our tax Endorsed Local Providers (ELPs) are here to serve you. These tax pros will take the time to get to know you and your tax situation so that you don’t miss out on any tax credits you qualify for.