Understanding Tax Credits

Deductions vs Credits

Deduction Vs. Credit.

When it comes to lowering your tax bill, there are two main players – tax deductions, and tax credits. But what’s the difference?

Most people are familiar with tax deductions and how they work – essentially, bringing down your taxable income number so you pay less. But fewer people are as well-versed in tax credits, so read the breakdown below to get started.tax credits

While tax deductions work by lowering taxable income, tax credits are a direct reduction of the tax due. After you figure out your taxable income and subtract your deductions, you calculate your tax due. You still have a chance to reduce that amount, often significantly, by taking advantage of any allowable tax credits.

The major tax credits usually get plenty of press, and a little controversy too, so you’ve probably heard of some of the big ones, like:

  • Earned income credit (EIC)
  • “Make Work Pay” credit
  • Lifetime learning credit
  • Saver’s tax credit
  • Green energy tax credits

The list goes on, and your tax adviser can help you sift through to find which ones are relevant to you. Despite the wealth of options, tax credits are relatively simple, and the good news is that you can take them whether you itemize or not. But they’re still part of the tax code, so there are confusing rules and exceptions to all of them. The main distinction for tax credits is whether they are refundable or non-refundable.

Refundable Tax Credits

Refundable tax credits are the ones that are easiest to embrace, because they have fewer restrictions and limitations. You can benefit from a refundable tax credit even if you have no tax liability and no withholding. There are several credits in this category, including the earned income credit (EIC) and the adoption expense credit. The EIC, which is available to low income filers, can provide you with a refund of several thousand dollars.

Non-Refundable Tax Credits & Exceptions

Non-refundable tax credits can also make a big difference. In fact, they can reduce your tax liability all the way down to nothing. But they have a major limitation: The amount of your credits can’t exceed the amount of tax you owe. In short, you’re not going to be able to use them to get a refund.

If you think about that example of the Making Work Pay credit above, if the situation were exactly the same except that the credit were non-refundable, you’d only be able to get the $300 to bring your tax liability to $0. You wouldn’t owe anything, but you wouldn’t get a $100 refund like you did in the above example.
– via www.moneycrashers.com

Which Credits Matter?

Well, when it comes to reducing your tax bill, or even getting money back, every credit matters! But below are a few of the most important ones for you to remember when it comes tax time. Which of these apply to your household?

Lifetime Learning Credit.

Like the American Opportunity Tax Credit, this also applies to education expenses and job training. However, Exantus said, the course or program does not have to result in a degree or certification. With this credit, worth up to $2,000, there is no limit on the number of years you can claim it, though it can’t be claimed in the same year as the American Opportunity Tax Credit.

Advanced Premium Tax Credit.

This credit is intended to help people below certain income limits pay health insurance premiums when they purchase insurance through the HealthCare.gov exchange. According to the IRS, the value is based on a sliding scale that takes into account income levels and other factors, such as household size and marital status. (When you apply for insurance on the exchange, it will estimate for you what your premium tax credit will be.)

Savers Credit.

This is a credit for people with low to moderate income levels who are making contributions to an eligible retirement plan, such as a 401(k) or individual retirement account, Exantus said. The credit can be worth up to $2,000, though the actual amount is calculated based on a percentage of the contributions and varies based on income levels.

Adoption Credit.

“While adopting a child can be expensive, it can be reduced by claiming the adoption credit,” Meighan at TurboTax said, adding that it’s worth up to $13,400 based on adoption expenses — and these can include adoption fees, attorney fees, court costs and travel.

Child Tax Credit.

Depending on your income level, whether you’re single or married and whether you’re filing jointly, you may qualify to earn up to $1,000 in tax credits per child. However, for you to be eligible to receive this credit, the IRS requires various criteria to be met. For example, the child must be under 17, a relative, claimed as a dependent on your federal tax return and living with you a certain percentage of the time.

Credit for the Elderly or the Disabled.

This credit can be worth up to $7,500. It applies to those who are 65 years or older or are retired on permanent disability and have taxable income. While this credit can be valuable, Meighan said they “have very low income limits, so they aren’t available to many.”
– via CNBC

What tax credits will you take advantage of?

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