- Many federal tax credits are designed to provide financial relief for particular circumstances.
- Tax credits reduce your actual tax bill dollar for dollar.
- Some tax credits are “refundable” to a certain extent, meaning that the government will pay you if the amount of the credit exceeds your tax bill.
What’s the best way to reduce the pain in paying taxes? By taking credit where credit is due.
In this case, we mean applying and qualifying for the many federal tax credits that are designed to provide financial relief for particular circumstances—whether you’re trying to save money, go to school, get health coverage, pay for a caretaker or even adopt a child. To find out what’s out there, what’s involved and how you can benefit, read on. (Official IRS links for each credit are provided so you can get details about each one, with respect to eligibility requirements, application specifics and other key information.)
The beauty of a tax credit is that it reduces your actual tax bill dollar for dollar, unlike a deduction, which reduces your income and lowers your tax bill only by the tax rate you would have paid on that amount. Moreover, some tax credits are “refundable” to a certain extent, which means the government will actually pay you if the amount of the credit exceeds your tax bill.
The tax reform bill passed by Congress at the end of 2017 takes effect in 2018. Also, in general, many provisions of the tax code have income caps and phase-outs and other wrinkles that may affect your actual tax liability. Be sure to work with a tax advisor or reliable tax software that clearly addresses your situation, especially if you are in the higher income brackets.
Earned Income Tax Credit. Commonly referred to as the EITC, this is intended as “a tax credit to help you keep more of what you earned,” according to the IRS. (Actually, that’s what all tax credits do.) To qualify, you must fall into a low- to moderate-earnings range and make income from employment, self-employment or another source. The credit amount depends upon your income and the number of children you have, if any. But it can go as high as just over $6,341.
As is often the case, there are rules involved that force many tax filers to make choices.
“It is possible to claim a dependent for EITC purposes, and not claim them as an exemption, if they meet the EITC tests,” says Kevin Hopson, co-founder and CEO of TaxPoint, an online tax-filing software company. “If your dependent has an Individual Taxpayer Identification Number (ITIN), they automatically do not qualify for the EITC. But having a Social Security number won’t discount them. And here’s a common ‘miss’ with the EITC: The dependent doesn’t necessarily have to be 18 or under. If they’re over 18, they’ll qualify if they’re disabled or a full-time student. A full-time student is someone from age 19 to 23 as of Dec. 31, and went to school for at least five months during the tax year. So if you have kids in college who fall into this category, they qualify!”
The EITC falls into the “refundable” category, so that in some cases tax filers will actually receive money from the government if the credit exceeds their tax bill. Unfortunately, government studies suggest that as many as 7 million households, some 25%, that are eligible for the EITC fail to claim it.
Saver’s Credit.The Saver’s Credit benefits those with low-to-moderate incomes, to give them an incentive to save toward retirement. It includes plans such as a traditional or Roth IRA, SIMPLE IRA, SARSEP, 401(k), 403(b), 501(c)(18) or the governmental 457(b). Calculated upon the first $2,000 socked away, the maximum credit for the 2017 tax year is $2,000 for an individual and $4,000 for married couples. However, the payout is often much less, reduced according to other deductions and credits taken.
“This is an often overlooked credit,” Hopson says. “What’s interesting here is that if you set aside money for an employer-sponsored savings plan, your taxable income is lowered by that amount. That, in turn, may make you eligible for more of the EITC. Plus, you receive the Saver’s Credit. This means you benefit greatly in multiple ways by contributing to your employer’s retirement plan. There’s also incentive for not withdrawing from the plan—if you take out more than you put in, you won’t qualify.” (Don’t forget that many work-sponsored retirement plans offer matches on contributions, which means even more money for participants.)
American Opportunity Credit.The American Opportunity Credit survived tax reform and will be good for 2018. It can be claimed for the first four years of postsecondary education. The student must be attending at least half time and pursuing a degree. Unlike other education tax credits, expenses for course-related books and supplies that aren’t paid to the school itself are eligible. It’s worth up to $2,500 of the cost of tuition, fees and course materials, and 40% of what remains after your tax liability is reduced to zero is refundable. A refundable credit can reduce your total tax owed to a negative number, meaning Uncle Sam pays you instead of the other way around. This means you could get a refund of up to $1,000 even if you owe no taxes.
Lifetime Learning Credit. The Lifetime Learning Credit also survived tax reform and is good for 2018. It helps cover qualified tuition and related expenses on the part of students pursuing undergraduate, graduate and professional degree courses. This includes courses intended to acquire or improve job skills, like a teaching certificate. In contrast to the AOTC, it does not require students to be pursuing a degree, can be claimed if attending only part time, and is not limited to the four years of undergraduate education. It’s worth up to $2,000 every tax year, but it’s nonrefundable. With a nonrefundable credit, you can only reduce your tax burden to zero, instead of getting money back through a refundable credit.
The Child Tax Credit. This longstanding tax credit reduces federal income taxes per child. It doesn’t matter if the child was born in late December. The credit will reduce your tax bill dollar-for-dollar. This was one of the major expansions in the 2017 tax reform bill. Starting in 2018, the credit amount will be raised to $2,000 from $1,000 before. Also, the threshold for phasing out the credit will be raised significantly from $110,000 to $400,000 in adjusted gross income for married and filing jointly. Plus, under the new law, up to $1,400 is refundable. Another addition from the 2017 reform is a $500 nonrefundable credit for qualifying dependents other than children.
Credit for Child and Dependent Care. This is for people who, in order to work or look for work, need to pay for services for either children, a spouse or dependent of any age who is physically or mentally unable to care for themselves. The credit for up to 35 percent of expenses is capped at $3,000 for a single dependent and $6,000 for two or more. The tax reform bill kept this credit unchanged, so it is valid for 2018.
Premium Tax Credit. The Premium Tax Credit, a fully refundable tax credit, helps citizens who are covered by a healthcare exchange through the HealthCare.gov marketplace. The intent here is to ensure that the monthly premiums are more affordable for middle and low-income Americans. It is only available to those who do not have access to employer-sponsored programs or government programs like Medicaid and Medicare. The tax reform bill does not affect this credit directly but it does remove the requirement to have health insurance—the individual mandate—from 2019 on, which is expected to prompt many people to opt out of health coverage and reduce the number eligible for this credit.
Adoption Credit. The Adoption Credit helps families offset the high cost of adopting a child. Qualified expenses include court/attorney fees, traveling expenses—such as meals and lodging while away from home—and any other associated costs of adoption. It applies to all forms of adoption except for that on the part of a step parent. For the 2018 tax year, the credit will be worth up to $13,810. If you adopt a special-needs child, you can claim the full credit amount even if your actual adoption costs are less. It is, however, nonrefundable, meaning the amount is limited to your actual tax liability, although it can be carried forward for five years. It was left unchanged in the tax reform bill.