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What is a tax credit?

 

What is a tax credit?

Elizabeth Rosen
by Elizabeth Rosen, Contributor

Many people are under the impression that tax credits and tax deductions are the same thing. While they are both types of tax breaks and are similar in many ways, there are several key differences that you need to be aware of. Most importantly, tax credits help reduce the amount of tax that you owe. On the other hand, a tax deduction only helps to reduce the amount of your taxable income.

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Tax credits can reduce your liability dollar-for-dollar. That being said, they cannot reduce your income tax liability to less than zero. Simply put, your gross tax liability is the amount you are responsible for paying before any credits are applied.

The majority of tax credits are non-refundable. This means that any excess amount expires the year in which it is used, and is not refunded to you. There are some refundable tax credits, though. With these, your tax refund can actually grow.

To get a better idea of how tax credits work and whether or not you qualify, you need to know what is available to taxpayers in your situation. Some of the most common tax credits include: the tax credit for child and dependent care expenses, education tax credits, the earned income tax credit, and the adoption tax credit.

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Just because you qualify for one tax credit does not mean that you qualify for the rest. For example, the Foreign Tax Credit is only available to those who pay taxes in a foreign country. Most Americans do not fit into this group, but may qualify for other tax credits.

How much are tax credits worth? Again, this depends on the particular credit you’re talking about. The Child Tax Credit, which is one of the most popular, can be worth up to $1,000.00 depending on your situation.

Just as the amount of each tax credit is different, so are the qualification guidelines. Since a tax credit is so helpful to the overall amount of money that you pay, it is essential that you are 100% accurate with this information. In other words, if you are unsure of whether or not you qualify, you may want to check with a tax professional before including the credit on your income tax return.

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Removing a tax credit is going to greatly affect how much you pay in taxes, thus it is better to avoid mistakes than to have the IRS catch them later on.

With this information you should have a better idea of what a tax credit is, as well as how these can help you pay less money in taxes.