What is a tax credit?

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In a Nutshell

A tax credit is a type of tax break that directly reduces the amount of tax you owe. Understanding how tax credits work and how to figure out which ones you qualify for could save you money at tax time.

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Claiming a tax credit can decrease how much you owe in federal income tax. And some credits, called refundable credits, can actually give you a refund even if you didn’t owe any tax.

The tax code includes lots of tax credits for taxpayers to take advantage of. So it’s important to know how they work, what you qualify for and how to ensure you get the most value possible on your tax return.



What is a tax credit?

A tax credit is a tax break that can reduce your income tax liability on a dollar-for-dollar basis. Some tax credits are for individuals while others are specifically for businesses.

In general, there are two types of federal income tax credits.

  • Refundable credits: If a refundable tax credit is worth more than the federal income tax you owe, the credit could result in a tax refund. For example, the earned income tax credit, or EITC, is a refundable credit that offers various maximum amounts based on adjusted gross income and how many qualifying children you have. Some credits are only partially refundable: They offer up to a certain amount for the credit but only a portion of that is considered refundable. The child tax credit is one example — it offers $2,000 per qualifying child, but only $1,400 of that amount is refundable.
  • Nonrefundable credits: While a nonrefundable tax credit could possibly drop your tax liability to zero, it won’t contribute to a potential tax refund. In other words, it’s possible you won’t always get the full value of nonrefundable tax credits. For example, the lifetime learning credit, or LLC, is worth a maximum of $2,000 and could reduce your tax obligation to zero if you qualify for it. But if you qualify for the maximum amount and only need $1,400 of the credit to reduce your tax obligation to zero, you can’t get the remaining $600 as a refund.

FAST FACTS

What's the difference between a tax deduction and a tax credit?

Tax credits and tax deductions often end up in the same discussion because they can both help reduce how much you owe the IRS. But there’s a key difference between the two tax breaks: Tax credits reduce your actual tax liability dollar for dollar, while tax deductions reduce your taxable income, which is the figure used to determine your tax liability.

In other words, tax deductions can help lower your taxable income bill, so it’s important to maximize yours. But they don’t have as much of a direct impact on your tax bill as tax credits.

Learn more about tax deductions vs. tax credits.

How much is a tax credit worth?

The amount you can claim with a tax credit varies from credit to credit and depends on multiple factors. Here are some tax credits and what they may be worth on a tax return.

Earned income tax credit

The earned income credit is tailored to provide low-income taxpayers and their families with a form of economic relief. The value of the credit is based on adjusted gross income and how many qualifying children you have, if any. For example, in 2019, single filers with no children and an AGI of less than $15,570 may qualify for the credit, while married joint filers with three or more qualifying children may qualify for the credit if they have an AGI of less than $55,952.

Child tax credit

For each qualifying child, you may qualify for a credit of $2,000. Remember though, only $1,400 of that amount is refundable.

Child and dependent care credit

If you incur eligible child and dependent care expenses while working or looking for work, you may qualify for a credit of up to 35% of those expenses as of 2018. But there’s a limit on the amount of expenses you can use to calculate the credit — in 2018 the limits were $3,000 for one qualifying person and $6,000 for two or more qualifying people.

Saver’s credit

If you’re a low- or moderate-income taxpayer and are saving for retirement with a qualified plan, you could qualify for a credit worth between 10% and 50% of your retirement contributions, based on certain factors like the contributions you make for the tax year. The amount of the credit depends on your AGI and filing status.

Premium tax credit

If you meet certain requirements, you may receive a tax credit to help you pay your premiums for health insurance purchased through the federal health insurance marketplace. The amount you qualify for is based on your household income and size, where you live, the ages of the people living in your household and other factors.

American opportunity tax credit

If you paid qualified education expenses for yourself or an eligible student, you may qualify for up to $2,500 in tax credits per eligible student for the first four years of higher education. Note that only 40% of that amount (up to $1,000) is refundable on your tax return.

Lifetime learning credit

You may be able to claim the lifetime learning credit in lieu of the American opportunity tax credit or after your eligibility on the AOTC runs out. The nonrefundable credit is worth up to $2,000, based on 20% of the first $10,000 of qualified education expenses each tax year. There’s no limit on how many years you can claim the lifetime learning credit.

Learn more about claiming education credits

How do I know if I can claim a tax credit?

Every credit comes with its own set of rules for who qualifies for it and how much it might be worth for you. The IRS website offers a lot of information on tax credits (and deductions), including requirements around qualifying for and claiming specific credits. And Credit Karma Tax® can help you determine if you qualify for a credit and how much it may be worth to you.

How do I claim a tax credit?

The process of claiming a tax credit can vary. You may, for example, need to provide certain tax forms, proof of qualified expenses and more.

If you’re doing your tax return on your own, you may also need to fill out new forms or worksheets to calculate how much you qualify for.

But the most important thing to remember: You must file a tax return in order to claim any kind of credit. So even if your income is low enough that you’re not required to file a federal tax return, if you’re eligible for a refundable credit and you want to claim it to get a refund, you’ll have to file a return.


Bottom line

If you qualify for a tax credit, it can directly reduce the amount of federal income tax you owe. And if you qualify for a refundable tax credit that reduces your tax obligation to zero, you may be able to get the balance of the credit refunded to you.

But it’s important to only claim tax benefits that you’re actually eligible for, so be sure you understand the qualifications for a credit before you try to claim it.

Relevant sources: IRS: Credits and Deductions for Individuals | IRS: Child Tax Credit and Credit for Other Dependents at a glance | IRS: Earned Income Tax Credit (EITC) | IRS Publication 5334: Do I Qualify for EITC? | IRS: Tax credits help offset higher education costs | IRS Publication 972: Child Tax Credit | IRS: Lifetime Learning Credit | IRS: EITC Income Limits, Maximum Credit Amounts and Tax Law Updates | IRS: Publication 503 – Child and Dependent Care Expenses | IRS Topic No. 610 – Retirement Savings Contributions Credit | IRS: The Premium Tax Credit – The Basics | The Taxpayer Advocate Service: Premium Tax Credit Change Estimator | IRS: American Opportunity Tax Credit | IRS: Lifetime Learning Credit


Troy Grimes is a tax product specialist with Credit Karma Tax®. He’s worked in tax, accounting and educational software development for nearly 30 years. He has a bachelor’s degree in business administration with an emphasis in business analysis from Texas A&M University. You can find him on LinkedIn.