In general, tax credits result in more significant tax savings than deductions. Tax credits are vital in reducing yearly tax obligations for Americans. According to IRS and Treasury data from 2022, approximately 31 million eligible workers and families across the country received about $64 billion in Earned Income Tax Credits, averaging more than $2,000 per recipient. Check out Beem to file your federal and state taxes without any hidden charges and get the maximum refund.
What is a Tax Credit?
The tax credit is a benefit that reduces the amount of tax you owe. It’s like a direct discount on your taxes. When you qualify for a tax credit, it lessens the total tax amount you must pay to the government. Unlike deductions that reduce taxable income, tax credits lower your tax bill dollar-for-dollar. This means they have a more substantial impact on reducing what you owe.
Types of Tax Credits
Tax credits fall into three categories: nonrefundable, refundable, and partially refundable.
Nonrefundable Tax Credits
Nonrefundable tax credits directly reduce the tax you owe until it reaches zero. Any excess amount beyond your tax bill doesn’t result in a refund. Sadly, the unused portion of these credits doesn’t carry over, which means it’s lost after filing.
This feature can be challenging for low-income earners who might not use the total credit amount. These credits expire after the tax year and can’t be carried forward. Examples include the Child Tax Credit, Adoption Credit, and Retirement Savings Contributions Credit for the 2022 tax year.
Refundable Tax Credits
Refundable tax credits are the most beneficial as they are paid out in full. A taxpayer receives the entire credit amount regardless of income or tax owed. If the credit reduces tax liability below $0, the taxpayer gets a specific amount refunded.
Famous examples include the Earned Income Tax Credit (EITC) for low- to moderate-income earners and the premium tax credit aiding individuals and families with health insurance premiums bought through the marketplace. These credits ensure full benefit access, even beyond a zero tax liability.
Partially Refundable Tax Credits
Partially refundable tax credits mix refundable and nonrefundable aspects. For example, consider the American Opportunity Tax Credit (AOTC) aiding postsecondary students. If a taxpayer’s tax bill hits $0 before using the full $2,500 deduction, the remaining portion can be claimed as a refundable credit, capped at 40% of the remaining credit or $1,000.
Initially partially refundable, the Child Tax Credit shifted to full refundability (up to $1,500-$1,600) due to tax law changes. This change, particularly in 2020 and 2021 under the American Rescue Plan, provided more comprehensive benefits.
What are the New Tax Credits for 2023?
New Tax Credits for 2023 impact various tax credits. Here, we mention some of the new tax credits:
- Child Tax Credit (CTC): Reduced to $2,000 from $3,600 in 2021 per dependent.
- Earned Income Tax Credit (EITC): Maximum reduced to $530 from around $1,500 in 2021 for eligible taxpayers without children.
- Child and Dependent Care Credit: Drops to $2,100 in 2022 from $8,000 in 2021 for maximum returns.
How Do Tax Credits Work in Practice?
Tax credits function as direct reductions in the tax amount an individual or business owes to the government. Here’s how they work:
- Example: Suppose you owe $2,000 in taxes but are eligible for a $500 tax credit. This credit reduces your tax bill to $1,500, saving you $500.
- Tax credits are applied after calculating taxes owed, directly cutting down the final amount.
- Different types of credits exist, like the Child Tax Credit or the Earned Income Tax Credit, each designed to lower specific tax liabilities.
2021 American Rescue Plan Changes
In March 2021, the American Rescue Plan, signed into law by President Biden, introduced significant changes. Eligible individuals received up to $1,400 in stimulus checks. Modifications to the Child Tax Credit were made for specific income brackets:
- The Child Tax Credit increased to $3,000 for children aged 6 to 17 and $3,600 for children under 6, previously capped at $2,000 per eligible dependent child.
- It became fully refundable, up from only $1,400, with refundable amounts rising to $1,500 and $1,600 for 2022 and 2023, respectively.
- The IRS issued advance payments for eligible households, providing up to half of the credit based on 2020 or 2019 returns.
- The bill removed the minimum income requirement, previously disqualifying families earning less than $2,500 annually.
These changes aimed to alleviate financial strains. For help navigating these adjustments and filing taxes hassle-free, consider utilizing Online Tax Filing services, simplifying the process for a smoother experience.
Example of a Tax Credit
Let’s take the Child Tax Credit (CTC) as an example of a tax credit. Let’s consider Sarah, a taxpayer with two qualifying children. If the CTC is $3,000 per child, Sarah may claim $6,000 as a tax credit. If her total tax liability is $8,000 and she qualifies for the total CTC, it directly reduces her tax bill to $2,000. Therefore, Sarah benefits from a $6,000 reduction in her taxes owed through the Child Tax Credit.
Common Tax Credits
Tax credits serve various purposes, offering financial relief and incentives for specific expenses or circumstances. Some widely used tax credits include:
Child and Dependent Care Credit
In 2022, the Child and Dependent Care Credit is nonrefundable, easing costs for caring for kids under 13 and aiding those working or seeking jobs. It’s accessible if arranging care for those without self-care, including a spouse or dependent. Claim up to $3,000 for one dependent or $6,000 for two or more. The credit varies from 20% to 35% based on income. Eligibility requires specific filing statuses: single, married filing jointly, head of household, or qualifying widow or widower with a qualifying child.
Lifetime Learning Credit
The Lifetime Learning Credit is valuable for any postsecondary education years, regardless of whether or not a degree is pursued. It covers 20% of up to $10,000 in education-related expenses, totaling a $2,000 credit for an eligible taxpayer, spouse, or dependent. In 2022, full credit is attainable if annual income stays below $80,000 for single filers or $160,000 for couples filing jointly.
Retirement Savings Contributions Credit
The Retirement Savings Contributions Credit aims to motivate low- and moderate-income earners to save for retirement. It offsets some of the initial $2,000 contributed to IRAs, 401(k) plans, and select workplace retirement schemes. Eligibility hinges on contributing to qualifying retirement plans, being over 18, not a full-time student, and not claimed as a dependent.
In 2022, the credit applies to individuals earning up to $34,000, heads of households earning up to $51,000, and married couples filing jointly earning up to $68,000, offering a maximum credit of $1,000 or $2,000 for couples.
Tax Credit Cuts and Changes
Tax credits undergo periodic changes by the government, with some programs expiring, extending, or adjusting income thresholds yearly. For instance, in 2022, the Earned Income Tax Credit reaches $16,480 for single filers without children, provided their earned and adjusted gross incomes stay below this limit.
Congress holds the power to eliminate or sustain federal tax credit programs. Examples include the termination of the Work Opportunity Tax Credit (WOTC), which benefits employers hiring veterans and marginalized groups, and the Employer Wage Credit for Activated Military Reservists, which assists small businesses paying National Guard and Reserve members during service.
These changes profoundly affect families and businesses, occasionally leaving them in financial jeopardy due to significant alterations or expirations of beneficial programs.
Tax Credit vs. Tax Deduction
Tax credits and tax deductions are favorable elements during tax season for any taxpayer, diminishing the amount owed to the government annually.
Nonetheless, their methods for reducing owed money vary.
| Tax Credit | Tax Deduction |
| Reduces the actual tax liability dollar-for-dollar. | Lowers taxable income, not the tax liability directly. |
| Applied after tax calculation, decreasing the amount owed. | Subtracts from total income before calculating taxes owed. |
| Varies by type and can result in refunds if it exceeds the tax owed. | Can be standard or itemized and varies by filing status. |
| Directly impacts the final tax amount due. | Affects taxable income, influencing the tax rate applied. |
| Examples: Child Tax Credit, Earned Income Tax Credit. | Examples: Standard Deduction, Itemized Deductions. |
What is a Premium Tax Credit?
The premium tax credit (PTC) is a refundable credit aiding eligible individuals and families in paying health insurance premiums obtained through the Health Insurance Marketplace. It assists in reducing the cost burden of health coverage, ensuring accessibility and affordability for those eligible.
How much is a tax credit worth?
Tax credits’ worth varies based on the specific credit, your filing status, income, and eligibility criteria. These credits directly diminish the owed tax amount, providing a dollar-for-dollar reduction in your tax liability.
Conclusion
Tax credits are necessary to reduce what you owe to the government. They directly cut down the tax, providing substantial relief by lowering the final bill. Whether the Child Tax Credit, Earned Income Tax Credit, or other types, these credits help individuals and families manage their tax liabilities, ensuring access to essential financial benefits. When it comes time to file your taxes, using tax credits effectively can help you save more money and pay less in taxes. Check out Beem Tax Calculator to get a quick and accurate estimate of your federal and state tax refund for free.
FAQs
What distinguishes a tax from a tax credit?
The main difference between a tax credit and a tax deduction is that the former lowers the tax owed to the government. In contrast, the latter lowers the income eligible for tax computation.
Can tax credits be carried over or backward, and do they expire?
Tax credits have different expiration dates, and some are carryover or retroactive. Examine each credit’s conditions to ensure it is used on time. Using thoughtful credits over several years will maximize your overall tax savings.
How can I find out which tax credits are relevant to me?
Finding the correct tax credits requires evaluating your situation, including your house ownership, school costs, and energy-saving upgrades. You can get assistance in comprehending and claiming relevant credits from the IRS website and tax experts.
