Tax Credit: Definition, Guide to 2023 Tax Credits
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Tax credits are the gold nuggets of the tax world. Qualifying for one feels better than finding $100 in your pants pocket. Here’s a brief look at how they work and an overview of the most common ones you may qualify for.
What is a tax credit?
A tax credit gives taxpayers a dollar-for-dollar reduction of their tax bill. This differs from a tax deduction, which is a dollar amount the IRS allows taxpayers to subtract from their adjusted gross income (AGI) to lower their taxable income.
Tax credits are offered on both the federal and state levels to incentivize certain actions, such as purchasing an electric vehicle, or to offset the cost of certain expenses (e.g., raising or adopting a child). To qualify for a tax credit, taxpayers usually must meet a strict set of criteria relevant to that credit.
» Dive deeper: Tax deductions vs. tax credits
How do tax credits work?
Tax credits come in three categories: nonrefundable, refundable and partially refundable. These classifications tell you how the credit will be applied to your tax bill. The majority of tax credits are nonrefundable. Good tax software should be able to walk you through which credits you may qualify for, and how to claim them.
Here's a breakdown of each type:
Nonrefundable tax credit
Nonrefundable tax credits reduce your tax liability by the corresponding credit amount. In other words, if you qualify for a $500 nonrefundable credit, you can apply that credit to your tax bill to lower your taxes owed by that same $500. The catch here is that this credit is most beneficial for people who expect to owe money — and that's because it can only lower or zero-out your taxes owed, but it won't result in a refund if the credit amount is larger than your tax bill.
Refundable tax credit
Refundable tax credits are highly sought-after tax benefits. And that's because claiming one can not only reduce your taxes owed but can also result in a refund. If you owe fewer taxes than the credit amount, the overage will be returned to you in the form of a refund after you file your tax return. For example, if you owe $500 and qualify for a $700 refundable credit, you'll get that extra $200 refunded to you by the IRS.
Partially refundable tax credit
The last type of credit is a middle ground between the two mentioned above. Partially refundable credits can lower your tax bill by the corresponding credit amount, and if your tax bill is lower than the credit amount, you may be able to get a partial refund for any remaining overage — but only up to a certain amount. For example, if the credit is worth $1,000, but only $500 of that is refundable, you may either have your tax liability lowered by $1,000 or get up to $500 back as a refund if taxes owed are less than the credit amount.
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A quick guide to popular tax credits
Some of the most popular tax credits fall into five categories. These sections below are just summaries; tax credits have lots of rules, so it's a good idea to consult a tax professional.
Tax credits for people with kids
Child tax credit. For the 2023 tax year (taxes filed in 2024), the child tax credit could get you up to $2,000 per kid, with $1,600 being potentially refundable through the additional child tax credit. You may qualify for the full credit only if your modified adjusted gross income is under:
$400,000 for those married filing jointly and $200,000 for all other filers.
The higher your income, the less you’ll qualify for.
Child and dependent care credit. Generally, the child and dependent care credit covers up to 35% of up to $3,000 of child care and similar costs for a child under 13, spouse or parent unable to care for themselves, or another dependent so you can work — and up to $6,000 of expenses for two or more dependents.
The percentage of allowable expenses decreases for higher-income earners — and therefore the value of the credit also decreases.
Payments made out of a dependent-care flexible spending account or other tax-advantaged program at work may reduce your credit.
Adoption credit. For the 2023 tax year, this covers up to $15,950 in adoption costs per child.
The credit begins to phase out at $239,230 of modified adjusted gross income, and people with AGIs higher than $279,230 don’t qualify.
Also, you can’t take the credit if you’re adopting your spouse’s child.
People who adopt children with functional needs can get up to the full credit even if their actual expenses were less.
Tax credits for low-to-middle-income households
Earned income credit. This earned income tax credit will get you between $600 and $7,430 in tax year 2023 depending on your tax-filing status and how much you make. You don't need to have children to qualify — but generally, the more children you have, the higher your potential credit amount.
If your AGI will be about $63,000 in 2023, it’s something to look into. However, if you had more than $11,000 of investment income, dividends, capital gains and a few other things in 2023, you won’t qualify.
Tax credits for investing in retirement
The saver’s credit: The saver's credit runs 10% to 50% of up to $2,000 in contributions to an IRA, 401(k), 403(b) or certain other retirement plans ($4,000 if filing jointly). The percentage depends on your filing status and income, but generally, it's something to look at if your AGI in 2023 was $73,000 or less if married filing jointly, $54,750 if head of household and $36,500 if single.
» Want another way to cut your tax bill? You can reduce your taxable income by contributing to a traditional IRA up until the April tax filing deadline.
Tax credits for education
American opportunity credit: The American opportunity tax credit runs up to $2,500 per student for tuition, activity fees, books, supplies and equipment during the first four years of college. It is partially refundable, so if the credit lowers your tax bill to $0, you can get up to 40% (limited to $1,000) back as a refund.
The student must be enrolled at least half time and can’t have any felony drug convictions.
Parents or qualified caretakers can take the credit if they qualify and claim the student as a dependent on their return.
Lifetime learning credit: The lifetime learning credit can get up to $2,000 for tuition, activity fees, books, supplies and equipment for undergraduate, graduate or even nondegree courses at accredited institutions.
Unlike the American opportunity credit, there’s no workload requirement.
The $2,000 limit is per return, not per student, so the most you can get back is $2,000 regardless of how many students you pay expenses for.
You can claim both the American opportunity credit and the lifetime learning credit on the same tax return, but you can't claim both for the same student.
Tax credits for 'green' purchases
Residential energy tax credits: Tax credits for energy efficiency, such as the solar tax credit, can get you up to 30% of the cost of solar energy systems, including solar water heaters, solar panels, battery storage technology and other home improvements.
Electric vehicle tax credit: For the 2023 tax year, the electric vehicle tax credit, also known as the clean vehicle credit, could get up to $7,500 for buying a new electric vehicle and up to $4,000 for the purchase of a used one.
