TAX CREDITSTax credits are usually worth more than a deduction. While deductions reduce the amount of income that can be taxed, tax credits reduce the tax itself, even to the point of not owing a tax or receiving a tax refund.
There are two types of tax credits, non-refundable and refundable. Non-refundable tax credits can reduce the amount to zero, but any excess is forfeited by the taxpayer. Refundable tax credits are credits that when the tax liability is reduced to more than zero, the excess amount is refunded to the taxpayer or credited to the following year's taxes.
Non-refundable tax credits result from:
- Taxes paid on income earned in a foreign country that is taxable in the U.S thereby preventing double taxation. A foreign tax credit can also be taken as a deduction.
- Payments made for child and dependent care.
- Payments made for educational purposes.
- Contributions made to a retirement savings account.
- Qualified children living in your household as defined by the IRS in Publication 972.
- Improvements made to the taxpayer's primary residence that increases the energy efficiency used by the property.
Refundable tax credits include:
- The Earned Income Tax Credit, which is a tax credit for low income workers who meet a certain income threshold and satisfy certain age and residency requirements.
- The Additional Child Tax Credit, which is a tax credit related to the previously mentioned non-refundable Child Tax Credit and can be claimed if the credit exceeds the tax liability and the taxpayer can claim the full Child Tax Credit.
- The American Opportunity Tax Credit, which is a tax credit for eligible expenses paid for eligible students in their first four years of post-high school study. It can reduce the tax liability to zero and if in excess of the tax liability, the taxpayer can claim a refund of up to $1,000.