There’s a good reason why people love tax credits. Unlike tax deductions, which lower your taxable income, tax credits lower your tax bill dollar for dollar. However, not every tax credit is the same. There are two different categories – nonrefundable and refundable.
Most tax credits are nonrefundable, which means they are subtracted from your income tax liability up to the amount you owe.
Once your tax liability equals zero, the unused portion of the credit expires and is no longer available to you.
The opposite is true for refundable credits. Any dollar amount remaining after your tax liability is covered is refunded to you.
As you complete your tax return this tax season, it’s important to know which credits are available.
Let’s take a closer look at some of the most popular tax credits.
Earned Income Tax Credit (EITC).
Qualifying for the EITC can be a big financial windfall as it’s one of the most generous refundable credits out there.
The maximum EITC for tax year (TY) 2015 is $503 if you have zero children living with you, $3,359 if you have one child, $5,548 if you have two children and $6,242 if you have three or more children.
The more children you have living with you, the easier it is to qualify for the credit, and the more credit you generally receive.
Although this credit is primarily designed for lower income households, you may be surprised by the amount of income you can earn and still qualify for at least a portion of the credit.
For example, the income cutoff in 2015 is $20,330 if you are married filing jointly and have zero children living with you. It’s $44,651 with one child, $49,974 with two children and $53,267 if you have three or more children in your home.
Child Tax Credit.
If you qualify, this credit allows you to reduce your federal income tax up to $1,000 per child under the age of 17.
However, the credit is limited to the amount of tax on your return, meaning it is nonrefundable. It also phases out as your income exceeds $75,000 ($110,000 if filing jointly).
While the Child Tax Credit doesn’t allow you to reduce your tax bill below zero, thereby forcing you to leave some of that money on the table, the Additional Child Tax Credit may be able to help.
This credit may be refundable and allow you to keep some or all of any of your unused Child Tax Credit.
As an added bonus, you can still take the dependency exemption for the same child if you qualify.
There are two different education credits available – the American Opportunity Tax Credit (formerly Hope Credit) and the Lifetime Learning Credit.
The American Opportunity Tax Credit may be the best deal for you as it is partially refundable.
If your eligible student qualifies, you get 100 percent of your first $2,000 in tuition and other expenses back as a credit and 25 percent of the next $2,000. That gives you a grand total of up to $2,500 in tax credits for every eligible student you claim on your tax return.
This applies to the first four years of college.
The Lifetime Learning Credit is the next best thing to the American Opportunity Credit.
It works with a wider range of higher education choices and for any number of years. The credit is worth up to $2,000 on your tax return, but does phase out as your income increases.
Both credits may apply to expenses you pay for yourself, your spouse and any dependents.
Foreign Tax Credit.
The Foreign Tax Credit is a little different than other credits as it helps you avoid paying tax on money that has already been taxed.
If you earn income in another country, either through employment or foreign investments, you may pay tax to a foreign government.
In that case, the IRS allows you to take a credit for any foreign taxes paid, so you don’t have to pay tax on the same income twice.
Think you don’t have foreign income? If you have international stocks or mutual funds, don’t be too sure.
Check your brokerage statements for any foreign tax paid during the year.
Some foreign income can be excluded from your U.S. taxable income, however you cannot take a foreign tax credit for taxes paid on excluded income.
Saver’s Credit (formerly Retirement Savings Contributions Credit).
This credit was designed to encourage people to save. If you qualify, it’s a real bonus – a credit of up to $1,000 goes into your pocket.
50% of the first $2,000 you put into an IRA or employer-sponsored plan. If you file a joint return, it’s 50% of the first $4,000, or a credit of up to $2,000.
Only taxpayers of relatively modest means benefit from this credit, however. It’s completely phased out by the time your income reaches $30,500 ($61,000 if filing jointly).
Which credits have saved you the most money in the past?