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 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.)
- This differs from a tax deduction, which 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.
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. For the 2019 tax year, you may qualify for the credit only if your modified adjusted gross income is under:
- $400,000 for married filing jointly
- $200,000 for everybody else
Child and dependent care credit. Generally, it’s 20% to 35% of up to $3,000 of child care 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 of allowable expenses decreases for higher-income earners — and therefore the value of the credit also decreases — but it never disappears completely.
- This credit isn’t refundable, which means it can take your tax bill down to zero but you don’t get the leftovers.
- 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 $529 and $6,557 in tax year 2019 depending on how many kids you have, your marital status and how much you make.
- If your AGI is less than about $56,000 in 2019, 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 2019, you won’t qualify.
- Note: You can get up to $529 in 2019 from the earned income credit even if you don’t have kids, though only if your income is less than $15,570 as a single filer or $21,370 if you’re filing jointly.
Adoption credit. For the 2019 tax year, this covers up to $14,080 in adoption costs per child.
- The credit begins to phase out at $211,161 of modified adjusted gross income, and people with AGIs higher than $251,160 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.
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 $64,000.
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 $68,000 as a single filer or $136,000 as a joint filer.
- 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.
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 2019, according to the IRS.
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.