What Is A Tax Credit?Published:
Understanding Tax Credits & How They Lower Your Tax Liability
Many people are under the impression that tax credits and tax deductions are the same thing. While they are both tax breaks and are similar in many ways, there are several key differences that you need to be aware of.
Most importantly, a tax credit reduces the amount of tax that you owe. On the other hand, a tax deduction only helps to reduce the amount of your taxable income.
How Do Tax Credits Work?
Tax credits reduce your tax liability dollar-for-dollar. Simply put, your gross tax liability is the total amount of tax you owe before any credits are applied.
The majority of tax credits are non-refundable, which means they cannot reduce your income tax liability to less than zero. In other words, any excess credit amount expires the year in which it is used and is not refunded to you.
However, there are some refundable tax credits, which are applied to your tax liability and can reduce it to below zero (if the tax credit is worth more than what you owe). With refundable credits, your tax refund can actually grow.
To get a better idea of how tax credits work and whether or not you qualify for any, you need to know what is available to taxpayers in your situation.
Types of Tax Credits
There are many different federal tax credits that can be claimed on the 1040 tax return. Each tax credit has its own specific rules for eligibility, so make sure you satisfy the requirements before claiming a credit on your income tax return.
Some of the most common tax credits include:
- Earned Income Tax Credit (EITC or EIC)
- Child Tax Credit (CTC)
- Child and Dependent Care Tax Credit
- Premium Tax Credit (PTC)
Remember that just because you qualify for one particular tax credit does not mean that you automatically qualify for others. 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?
It depends on the specific credit you’re talking about. The Child Tax Credit (CTC), which is one of the most popular, can be worth up to $2,000 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.
If you are unsure about whether or not you qualify, you may want to check with a tax professional before including the credit on your income tax return. Removing a tax credit is going to greatly affect how much you pay in taxes, so 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, and how this type of tax break can help you pay less money to the IRS.