Learn all about what a tax credit is and how it works. It’s essentially a sum of money you may be eligible to receive from the government if you qualify.
Tax season comes around at the beginning of each year for everyone, including individuals, households, and small businesses. When tax filers start filling out their tax returns, they often look for ways to reduce their tax obligations so they can pay less in taxes. By reducing your tax liability, tax filers can keep more money for themselves, their household, and their businesses.
There are a few ways to reduce tax liability including tax exemptions, tax deductions, and tax credits. All of these are tax benefits that some people and businesses can qualify to use. Then, each one of these tax benefits can reduce how much you pay in taxes in different ways.
Tax deductions help by reducing the amount of your taxable income. On the other hand, tax credits help by reducing the amount of tax you owe. There is more to know about what tax credits are and how tax credits work, and then there are also different kinds of tax credits that could apply to you.
Luckily, you can use experience tax professionals through the tax services at Check City to make sure you get all the tax credits you might qualify to use. Visit any Check City store with your tax documents and our friendly tax preparation experts will make sure to get you the best outcome possible for your tax situation.
Key Takeaways:
- Learn the answer to what is a tax credit?
- Understand how tax credits work
- Learn about the 3 different types of tax credits
- Find out which tax deductions could apply to you
What is a Tax Credit?
A tax credit is a reduction in taxes owed or an increase in your tax refund. It’s a type of tax benefit offered by the government to individuals or businesses. This tax benefit works by directly reducing the amount of taxes you owe.
When you file taxes each year, the amount of taxes you owe is calculated on your tax return. If you qualify for any tax credits, then the amount of taxes you owe can be reduced.
This kind of tax benefit may be offered by the federal, state, or local government to help out certain groups of people, like businesses, or to incentivize something that is good for the economy or community.
How Do Tax Credits Work?
Tax credits work by directly lowering the amount of taxes you owe. Other tax benefits help you pay less in taxes more indirectly, but tax credits are some of the most direct benefits you can qualify to use.
Because these are applied directly to the amount of taxes you owe, you will first need to calculate what you owe in taxes. This may include calculating tax deductions first so you can get the amount of taxable income you have, and then calculating how much you owe in taxes from the amount of taxable income you have.
The process for an individual to apply tax credits to their tax return might look like this:
Step 1: Determine which tax credits you are eligible to use.
Step 2: On your 1040 tax form, identify and claim the tax credits you wish to apply to your tax return following the instructions on the form closely to make any necessary calculations.
Step 3: Include supporting documentation like receipts, invoices, forms, or records in your submitted tax return.
For example, a taxpayer might find that they owe $5,000 in taxes, but that they are eligible for a $1,000 tax credit. The credit is subtracted from the amount owed, so that after the credit is applied, the taxpayer owes $4,000 in taxes instead.
Different Types of Tax Credits
There are 3 different types of tax credits that could help you out this tax season: nonrefundable, refundable, and partially refundable.
These different types of credits could mean that the credit is subtracted from a taxpayer's overall owed taxes, added to a taxpayer's tax refund, or a mix of both.
Nonrefundable Tax Credit
A nonrefundable tax credit is a type of tax credit that reduces the taxes owed to zero but does not result in a tax refund. It's called a nonrefundable tax credit because if the credit is bigger than the amount of taxes owed, then that extra credit is not refunded to the taxpayer in a tax refund. Instead, the taxes owed are just zeroed out.
For example, if a taxpayer owes $5,000 in taxes and their nonrefundable tax credit is $6,000, then this credit reduces their taxes owed to zero and the surplus credit of $1,000 is not refunded in any way to the taxpayer.
Refundable Tax Credit
A refundable tax credit is a type of tax credit that reduces the taxes owed to zero and results in a tax refund. It's called a refundable tax credit because if the credit is bigger than the amount of taxes owed, then that extra credit is refunded to the taxpayer in a tax refund.
For example, if a taxpayer owes $5,000 in taxes and their refundable tax credit is $6,000, then this credit reduces their taxes owed to zero and the surplus credit of $1,000 is refunded to the taxpayer.
Partially Refundable Tax Credit
A partially refundable tax credit is a type of tax credit that reduces the taxes owed to zero and refunds a portion of the excess credit. It's called a partially refundable tax credit because if the credit is bigger than the amount of taxes owed, then that extra credit is partially refunded to the taxpayer in a tax refund. But only a portion of that extra credit is refunded.
For example, if a taxpayer owes $5,000 in taxes and their partially refundable tax credit is $6,000, then this credit reduces their taxes owed to zero and a part of the surplus credit of $1,000, like $500 for example, is refunded to the taxpayer.
Examples of Tax Credits
There are several examples of tax credits that could apply to you and your tax situation like credits for parents, tax breaks for homeowners, and more.
Child and Dependent Care Credit
The Child and Dependent Care Credit is a tax credit for parents and caregivers that financially helps with child and dependent care costs. This can help taxpayers with childcare expenses and other dependent care expenses.
Lifetime Learning Credit
The Lifetime Learning Credit is a tax credit that financially helps taxpayers with educational expenses. This can help taxpayers with expenses from any eligible educational program.
Retirement Savings Contributions Credit
The Retirement Savings Contributions Credit is a tax credit that rewards taxpayers for making contributions to eligible retirement accounts. This can also be called the Saver's Credit. It can help taxpayers who are making contributions to a retirement savings account.
Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is a tax credit designed for taxpaying workers who make a low to moderate income. This can financially help employees who make a low to moderate annual income.
Tax Credit vs Tax Deduction
Tax credits and tax deductions are both tax benefits that can financially assist taxpayers. But they both work in different ways.
The main difference between tax credits vs tax deductions is that credits lower the amount of taxes you owe, and deductions lower the amount of income subject to taxes.
