If you are one of those people who often confuses tax credits with tax deductions, you are not alone. One of the more common reasons for the confusion is that taxpayers are not eligible for the tax credits, so they have no reason to “get involved.” Then their personal income situation changes and they don’t know how to maximize the use of the credits. The good news is that it only requires a bit of education to start putting more tax money back in your own pocket.
The tax reality is that a tax credit is applied against the total tax you owe, while a tax deduction only reduces the total amount of your income that is subject to taxation. If you owe $500 before applying any tax credit and have $500 in total tax credits, the amount you owe would be reduced to $0.
But because the IRS always finds ways to complicate your tax return there are two categories of tax credits – refundable and non-refundable. The easiest way to remember the difference is that a refundable credit can result in the government owing you money. The non-refundable credit can only bring the total tax you owe to $0.
Because they are so important, here are 7 tax credits you need to know about.
1. The Child Credit
If you have qualifying children you can use this one. The child has to be under the age of 17 and you provide more than 50% of their support for the tax year. You can apply as much as $2000 against your taxes, but the refundable part of the credit stops at $1400. This credit is per child so if you have a pair of darlings your maximum credit is $4000 and your maximum refundable credit is $2800 ($1400 x 2). There is a restriction based on your Adjusted Gross Income, so calculate that first and then see whether you are subject to any restrictions.
2. The Other Dependents Credit
If your children are over the age of 16 then you can use this credit. But it also applies to elderly parents for who you are providing at least 50% of their annual living expenses. This credit is not as generous as the Child Credit, as it limits the credit to $500 and is 100% non-refundable.
3. Earned Income Tax Credit (EITC)
This is a credit most people know about and has been around for a long time. It is an income based credit, so higher wage earners are not likely to be eligible. But this credit is exclusive of whether you have children or not. The 2018 credit is set at $519 even if you have 0 dependents (other than yourself). If you make less than $50,000 a year this is a credit that should add to your potential refund.
4. The Lifetime Learning Credit
Whether you advance your education one college course at a time or are a full time college student working on your degree, this credit can definitely benefit you. In fact, even if you are taking classes for personal development you may be eligible to get a piece of this credit. The restriction is that you will in most cases have to make less than $50,000 a year. If you qualify you can get 20% of the money you spent to attend the classes up to a maximum of a $2000 credit. But this is a non-refundable credit, so you can’t add to any refund by applying this credit.
5. The Saver’s Credit
Formally known as the Retirement Savings Contributions Credit, its goal is to help people focus on saving for retirement. The basic requirement is that you have one of the many popular retirement accounts such as a Roth IRA, 401(k), 403(b), and SEP-IRA. The amount you contribute to the account will determine the amount that is eligible for the credit to a maximum of $2000. You won’t be able to double down on your savings as it is a non-refundable credit, but the credit is tiered so you can get as much as 50% of your contribution applied to your taxes.
6. The American Opportunity Tax Credit
This is the second educational credit and has a number of restrictions attached to it. The good news is that as much as $1000 of the credit is refundable, so there is money to be had here. Basically this credit is aimed at college students who are pursuing a specific goal, such as a degree or certificate. You need to be enrolled for at least a half-time status, and it only applies to the first 4 years of undergraduate work. The income level is set for the taxpayer, not the student, and is generally $80,000 for most taxpayers.
7. The Federal Adoption Tax Credit
Those who have chosen to adopt a child can apply this credit as a way to relieve some of the financial challenges involved with adoption. A qualifying child will be under the age of 18 or physically or mentally incapable of caring for themselves. The credit maxes out at $13,810 but can be used for each adopted child. High wage earners making more than $201,740 will see the amount of the credit decrease, and if you make more than $247,140 you are ineligible for the credit.