Reduce your tax liability by taking advantage of tax credits for which you qualify.
Let's face it; nobody likes paying taxes. There are many ways you can reduce your tax liability, but tax credits are one of the best. If you aren't one of the 8 out of 10 Americans who qualifies for a refund each year, a tax credit can help you reduce your tax liability. Don't confuse a tax credit with a tax deduction – credits are much better!
But how can you learn which tax credits you qualify for? In this article, you'll learn about the most common tax credits so you can minimize your tax burden and maximize your refund.
How Tax Credits Work
Tax credits are commonly confused with deductions. The primary difference between a tax credit and a deduction is that a tax credit offsets the amount of taxes you owe, while a deduction reduces the amount of the income that is considered taxable.
Tax credits are generally either refundable or non-refundable. If you owe $500 in taxes and apply an $800 non-refundable tax credit, you can only bring your tax liability to $0. But if that $800 was a refundable tax credit, you'd be eligible for a $300 refund.
Examples of refundable tax credits include The Child and Dependent Care Credit, The Earned Income Tax Credit, and The Retirement Savings Contributions Credit (Saver's Credit).
This fact makes tax credits far more valuable than deductions, especially if you're in a higher tax bracket. The more income taxes you pay throughout the year, the higher your opportunity for a tax refund.
Reducing your taxable income can also shrink your refund opportunity. Credits are applied dollar for dollar to the taxes owed for the year.
The degree to which deductions can help depends on your tax bracket. If you are in a high tax bracket, you could still owe a large sum, even if you have many deductions.
The government does place income limits and other restrictions on who can claim a tax credit, but the opportunities to claim credits are broad. Check with your tax advisor to learn more about which credits are available at the state level in addition to Federal tax credits.
State and federal tax credits each have eligibility criteria. Not qualifying at the Federal level won't mean you can't qualify for a similar tax credit at the state level.
Tax credits commonly fall into a few common categories related to being a parent, paying for college, earning income, and investing.
Tax Credits for Parents
One of the best-known tax credits for people with kids is the Child Tax Credit. With the child tax credit, you can qualify for up to $2,000 per child and $500 for other dependents as long as you provide more than 50 percent of their support.
This credit is available to married couples filing jointly as long as their combined adjusted income is less than $400,000 for the year. Everyone else qualifies for the tax credit with an income of less than $200,000 for the year.
The higher your income, the less you'll receive as a credit. The second most common tax credit for parents is the tax credit you receive for childcare.
As of 2019, parents receive up to 35 percent off dependent child care expenses as long as their child is under 13. Care for an incapacitated spouse or parent also qualifies.
The limit is $3,000 in expenses unless you have more than one child. Parents with multiple children or dependents can qualify for up to $6,000 in expenses.
The child and dependent care credit will reduce your tax burden, but it isn't refundable. If your tax liability goes below zero, you won't receive the remainder in the form of a refund. Like the child tax credit, higher earners won't receive the full amount of this tax credit.
Tax Credits for Retirement
The Saver's Credit for retirement contributions ranges from 10 to 50 percent of up to $2,000 of IRA contributions. This credit can also be applied to other retirement plans like a 401(k), 403(b), and other investment vehicles.
The percentage varies depending on your income and filing status. You'll usually get the most considerable benefit with an adjusted gross income of less than $64,000.
You won't qualify for this credit if you are a full-time student or can be claimed as a dependent on someone else's tax return.
Tax Credits for Education
Paying for higher education has its benefits. In addition to helping you earn a degree, paying for school can mean qualifying for the Lifetime Learning or American Opportunity tax credits.
The Lifetime Learning tax credit allows you to receive up to $2,000 for tuition, activity fees, books, and other supplies to earn a degree or certificate from an accredited institution.
If your adjusted gross income is more than $68,000, you might not qualify for this credit. Still, you can try combining this credit with the American Opportunity credit to increase your chances.
The American Opportunity Credit offers up to $2,500 per student for tuition, activities, books, and other supplies during the first four years of college. Students must be enrolled at least half time to qualify.
Anyone with felony drug convictions is not eligible to receive this tax credit. Parents are eligible to take this credit as long as the student is still considered a dependent on their tax return.
Tax Credits for Having a Job
Earned Income Tax Credits are a great option for low to moderate-income families. The income limits vary based on the number of children in your family.
A single person with no kids can't earn more than $15,570, while a married couple filing jointly with more than three children can't earn more than $55,952 to qualify.
This tax credit is refundable, which means that after your tax liability is reduced, you get what's leftover as a check from the IRS. This could mean thousands of dollars coming back to you if you earn the maximum credit amount of $6,557.
Learning Your Limits
Tax credits vary each year with changes in tax law. Using tax software where updates are automatic or consulting with a tax advisor are two of the best ways to get accurate information.
Depending on your income bracket, there are potentially thousands of dollars waiting for you if you know which credits to claim.