Tax credits are a powerful component of your tax return that can significantly reduce how much you owe to the IRS. To help you fully grasp their value, we’ll define key terms and break down several common tax credits, providing thorough examples to illustrate how they can benefit you. Whether you’re a first-time filer or someone looking to deepen your tax knowledge, this article clarifies what you need to know about tax credits.
Non-Refundable vs. Refundable Tax Credits:
Tax credits can directly reduce the amount you owe in taxes and are categorized as either non-refundable or refundable. Non-refundable credits can lower your tax bill to zero, but not below, meaning they can’t generate a refund on their own. Refundable credits are more generous: if they’re more than what you owe in taxes, the IRS will send you the difference as a refund.
The Child Tax Credit (CTC):
The CTC is a credit offered to parents or guardians of children under the age of 17 at the end of the tax year. A qualifying child must be a U.S. citizen, national, or resident alien, and must be claimed as a dependent on your tax return. They should be related to you (son, daughter, stepchild, foster child, sibling, or a descendant of any of these), have lived with you for more than half the tax year, and provided less than half of their own financial support during the year.
Example: Alex and Jordan are married and have two children, ages 5 and 8. Both children have Social Security numbers and have lived with them all year. With a household income of $75,000, they’re eligible to claim the CTC. If the CTC is $2,000 per child, they could reduce their tax liability by $4,000. If their tax liability before the credit was $3,500, the CTC would reduce their tax bill to zero, and if the credit is refundable, they might also receive a refund.
The American Opportunity Tax Credit (AOTC):
The AOTC helps with costs during the first four years of higher education. To qualify, the student must be pursuing a degree or other recognized education credential and be enrolled at least half-time for at least one academic period beginning in the tax year. Expenses that qualify for the AOTC include tuition and fees, course-related books, supplies, and equipment.
Example: Zoe is a full-time undergraduate student in her first year. Her tuition and fees for the year total $5,000. Zoe’s parents can claim the AOTC on their tax return, which offers a credit of 100% of the first $2,000 and 25% of the next $2,000 spent on qualified education expenses. They are eligible for a credit of $2,500. If their tax bill is $2,500 or more, the AOTC reduces it to zero, with up to $1,000 being refundable if their tax liability is less than the credit amount.
The Earned Income Tax Credit (EITC):
The EITC is designed to support low- to moderate-income working taxpayers, especially those with children. The amount of the credit depends on the taxpayer’s income, filing status, and number of children. To qualify, you must have earned income from working for someone else or running a business or farm, and your investment income must be below a certain level.
The Lifetime Learning Credit (LLC):
The LLC is for taxpayers who have incurred education expenses from post-secondary education or courses to acquire or improve job skills. There is no limit on the number of years you can claim the credit, and it’s worth up to 20% of the first $10,000 of qualified education expenses, for a maximum of $2,000 per tax return.
Example: Samantha is taking a part-time course at her local community college to improve her job skills, and she pays $2,500 in tuition fees. She can claim the LLC, giving her a credit of $500 (20% of her tuition). If her tax liability is $500 or more, the LLC would reduce it to zero. If her liability is less than $500, she would not receive a refund for the difference since the LLC is non-refundable.
Energy Credits:
The Residential Energy Efficient Property Credit is for homeowners who install alternative energy equipment, such as solar panels, solar-powered water heaters, and wind turbines.
Adoption Credit:
This credit covers qualified adoption expenses, such as court costs, attorney fees, and travel expenses.
This is by no means an exhaustive list of tax credits available to taxpayers. Tax credits can be a boon to taxpayers, providing significant savings and, in some cases, a refund. Understanding each credit’s requirements and how it applies to your situation can ensure you’re getting the maximum benefit you’re entitled to. While the examples provided shed light on how these credits work, always verify current tax laws and consult with a tax professional if you have questions about your specific circumstances.
How We Can Help
As you navigate the complexities of tax credits and work to secure every advantage they offer, remember that expert guidance is within reach. Spartan Tax Group specializes in clarifying the tax process and ensuring you receive every credit you qualify for. We’re committed to personalized service that maximizes your benefits and minimizes your stress. Reach out to us today for a free consultation.
