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 some of the most common ones work — maybe you’ll find some cash here, too.
First, a word about the lingo
Be sure you know the difference between a tax deduction and a tax credit.
- A tax deduction is a dollar amount the IRS allows you to subtract from your adjusted gross income (AGI), making your taxable income lower. The lower your taxable income, the lower your tax bill.
- A tax credit is a dollar-for-dollar reduction in your actual tax bill. A few credits are even refundable, which means that if you owe $250 in taxes but qualify for a $1,000 credit, you’ll get a check for $750. (Most tax credits, however, aren’t refundable.)
Either way, as the simplified example in the table shows, a $10,000 tax credit makes a much bigger dent in your tax bill than a $10,000 tax deduction does.
|* Example rate only. The United States uses a progressive tax system.|
|A $10,000 tax deduction…||…or a $10,000 tax credit?|
|Less: tax deduction||($10,000)|
|Less: tax credit||($10,000)|
|Your tax bill||$22,500||$15,000|
Some of the most popular tax credits fall into three categories. These are just summaries; tax credits have lots of rules, so it’s a good idea to consult a tax professional. Your state may offer a variety of tax credits as well.
1. Tax credits for people with kids
Child tax credit. This could get you up to $2,000 per kid and $500 for a non-child dependent.
- The higher your income, the less you’ll qualify for.
- In 2018, the credit starts phasing out a $200,000 of adjusted gross income for single filers and at $400,000 of adjusted gross income for joint filers.
Child and dependent care credit. Generally, it’s 20% to 35% of up to $3,000 of daycare and similar costs for a child under 13, an incapacitated spouse or parent, or another dependent so you can work — and up to $6,000 of expenses for two or more dependents.
- The percentage is income-based: Families with AGIs of $15,000 or less can get a credit of 35% of their expenses, but that shrinks by one percentage point for every extra $2,000 of income.
- The rate is 20% for AGIs of more than $43,000.
- Payments made out of a dependent-care flexible spending account or other tax-advantaged program at work may reduce your credit.
Earned income credit. This credit will get you between $3,461 and $6,431 in tax year 2018 depending on how many kids you have, your marital status and how much you make.
- If your AGI is less than about $55,000, it’s something to look into, though if you had more than around $3,500 of investment income, dividends, capital gains and a few other things in 2018, you won’t qualify.
- Note: You can get up to $519 in 2018 from the earned income credit even if you don’t have kids, though only if your income is less than $15,270 as a single filer or $20,950 if you’re filing jointly.
Adoption credit. For the 2018 tax year, this covers up to $13,840 in adoption costs per child.
- The credit begins to phase out at $207,580 of modified adjusted gross income, and people with AGIs higher than $247,580 don’t qualify.
- Also, you can’t take the credit if you’re adopting your spouse’s child.
- People who adopt special-needs children can get up to the full credit even if their actual expenses were less.
- In some cases, the adoption need not be final before you claim the credit; in others, it must be.
2. Tax credits for investing in education or for retirement
The saver’s credit: This 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 is less than $63,000.
Tax credits are the gold nuggets of the tax world.
American Opportunity credit: This credit runs up to $2,500 per student for tuition, activity fees, books, supplies and equipment during the first four years of college.
- The student must be enrolled at least half time and can’t have any felony drug convictions.
- This credit phases out with income, so you may not qualify if your AGI is higher than $90,000 as a single filer or $180,000 as a joint filer.
- Parents can take the credit if they qualify and claim the student as a dependent on their return.
Lifetime Learning credit: With this credit, you 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.
- This credit also phases out with income, so you may not qualify if your modified AGI is higher than $66,000 as a single filer or $132,000 as a joint filer.
- If you take this credit, you can’t take the American Opportunity credit, and vice versa.
3. Tax credits for big-ticket ‘green’ purchases
Residential energy tax credit: This one gets you up to 30% of the cost of solar energy systems, including solar water heaters and solar panels in 2018.
Plug-in electric-drive motor vehicle credit: You could get up to $7,500 for buying a plug-in electric vehicle. The IRS requires that the car have at least four wheels and be propelled “to a significant extent” by a rechargeable battery with a capacity of at least four kilowatt hours. The minimum credit is $2,500 but rises depending on battery capacity. You must buy the car new; used cars don’t count.
A previous version of this article misstated one aspect of eligibility for the adoption credit. This article has been corrected.