What Is a Tax Credit?
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It's never too early to start getting your finances in order for Tax Day. And part of that is figuring out what you'll be on the hook to pay the IRS.
Luckily, applying tax credits can lower your federal income tax bill — and, in some cases, even increase your refund. Taxpayers with families, clean vehicles, homes, retirement savings and more can qualify for these credits. You may be eligible for more than one tax credit, too, so it's crucial to understand their ins and outs.
What is a tax credit?
A tax credit is an amount of money that a taxpayer can claim in order to decrease their tax liability, or how much they owe in taxes in a given tax year. Technically, tax credits are incentives, so your eligibility is usually tied to qualities, behaviors or actions the government wants to reward. (Think: caring for kids, going to college, being environmentally friendly, et cetera.)
How do tax credits work?
You qualify for a tax credit based on personal characteristics and then can claim it on your individual income tax return when you go to file your taxes. You may need to fill out an extra form or provide supporting documentation.
Tax credits are what's called dollar-for-dollar; they get subtracted directly from your federal tax liability. If you owe $500 in taxes and can claim a $100 tax credit, for example, then you'll only owe $400.
Here's another example. Say you were in a high-earning couple in 2023 and had a $250,000 AGI with an effective tax rate of 20%. Your tax bill was about $50,000. But if you'd claimed a $1,000 tax credit, that bill would have been $49,000 — and your effective rate would have dropped to 19.6%.
What is the difference between a tax credit and a refund?
Tax credits and refunds are not the same thing. A tax refund is the money you get back from the IRS when you've paid the government more what you owe, whereas a tax credit is a reduction of your bill.
Some tax credits are nonrefundable, meaning the tax credit is only good up to the amount you owe, and you sacrifice whatever's left over after reaching zero. But some are refundable, meaning the money is yours even if the credit is more than your tax bill. For example, if you owe $400 and claim a $500 refundable tax credit, you'd get $100 added to your federal tax refund.
What is the difference between a tax credit and a deduction?
Tax deductions impact your taxable income — they reduce the amount of money your taxes are based on in any given tax year. Credits have a more direct impact, as they lower your taxes owed (or increase your refund).
Think about the standard deduction, which the vast majority of taxpayers take: For 2024, it decreases a single filer's taxable income by $14,600 — it doesn't decrease your tax bill by $14,600, nor do you get a refund of $14,600 (sorry).
Popular types of tax credits
There are several commonly claimed tax credits; here, we're focusing on federal tax credits that individual taxpayers can claim (as opposed to state tax credits or ones intended for employers). Eligibility varies based on your own financial situation.
Child tax credit
The child tax credit is intended for people who are financially supporting — you guessed it — a child. For 2023, the credit was worth up to $2,000 per kid.
To qualify, a kid must be under age 17 at the end of the year; have a Social Security number; be your child, stepchild, foster child, sibling or descendant; live with you for more than half the year; be claimed as your dependent; and pay for no more than half of their own expenses. You'll also have to satisfy income requirements.
You may remember that in 2021, the pandemic-era American Rescue Plan Act expanded the child tax credit to $3,000 per child between 6 and 17 years old and $3,600 per child under 6. It made the child tax credit fully refundable and allowed taxpayers to get half of the money in advance monthly payments. This provision expired at the end of 2021, and though several legislators have taken steps to revive it, Congress has not revived the expanded child tax credit.
Today, the child tax credit has a refundable and nonrefundable portion. For 2023, the refundable part was worth up to $1,500; it's called the additional child tax credit.
Child and dependent care credit
A separate credit from the child tax credit, this is intended for taxpayers who paid care expenses for another person while they worked or looked for work. To qualify, that person must be under age 13; a spouse who's unable to care for themselves and lives with you at least half of the year; or someone who's unable to care for themselves, lives with you at least half the year and is (or would typically be) your dependent.
The child and dependent care credit covers 20% to 35% of your work-related expenses, depending on your income, up to a maximum of $3,000 for one person ($6,000 for two or more people).
Earned income tax credit
The earned income tax credit, or EITC, is intended for workers with low to moderate incomes. To qualify in tax year 2024, you must have a Social Security number, be a citizen or resident alien, have a certain amount of earned income, not have foreign income, and have less than $11,600 in investment income.
How much your EITC is depends on how many eligible children you have (the more kids/relatives you claim, the higher your income and credit can be). For 2023, the maximum EITC without kids is $632. With one child, it's $4,213; with two, it's $6,960. For three or more kids, it's $7,830.
Keep in mind that if you claim the EITC or additional child tax credit (mentioned above), the IRS is legally obligated to hold onto your tax refund until mid-February.
American opportunity tax credit
The AOTC, as it's abbreviated, is intended for people who are paying for certain higher education expenses for a qualifying student. College students are eligible as long as they're pursuing a degree or other credential, are enrolled at least half time in at least one academic period in the tax year, not have graduated yet, and not have a felony drug conviction.
Taxpayers can't claim the AOTC for more than four years and must also satisfy income requirements.
The AOTC relies on Form 1098-T, which is a tuition statement. The tax credit is $2,500 max per student (100% of the first $2,000 paid plus 25% of the next $2,000). If claiming the AOTC makes your tax liability zero, you're able to claim 40% of what's left over, up to $1,000, as a refund.
The IRS also offers the lifetime learning credit, or LLC. The LLC doesn't require a student to be pursuing a degree, nor does it limit the number of tax years you can claim it — you just can't claim both the AOTC and LLC for the same student or same expenses on one tax return. Other eligibility requirements are listed on the IRS website.
New clean vehicle tax credit
This nonrefundable tax credit is intended for people who buy certain new, plug-in electric vehicles (or fuel cell electric vehicles). To qualify for the EV tax credit, you have to purchase it for personal use mostly in the U.S. and satisfy income requirements.
Requirements for this tax credit are tied to when you received the car in 2023, not when you bought it.
If your vehicle was placed in service between Jan. 1 and April 17, 2023, you're eligible for $2,500 plus $417 if it has at least 7 kilowatt hours of battery capacity and $417 for each kilowatt hour of capacity beyond 5 kilowatt hours, up to $7,500 total.
If your vehicle was placed in service after April 18, 2023, it has to meet those conditions as well as mineral and battery requirements (which are $3,750 apiece), though the maximum credit is still $7,500.
There are certain price, weight and assembly requirements the vehicle must meet in order to qualify for the EV tax credit, as well. If you bought a used EV from a dealer in 2023, you might qualify for a used clean vehicle credit; there's more information about that on the IRS website.
Saver's credit (retirement contributions tax credit)
This tax credit is intended for certain low- and moderate-income taxpayers who are saving for retirement through an employer-sponsored plan (like a 401(k) or 403(b)) or an individual retirement account (IRA).
Taxpayers who are at least age 18, aren't dependents and aren't students can qualify, though your eligibility for and the amount of the credit depends on your adjusted gross income. You claim 10%, 20% or 50% of your retirement contributions up to $2,000 ($4,000 for married couples). The maximum credit, therefore, is $1,000 ($2,000 for married couples).
According to the IRS, over 9 million taxpayers claimed the saver's credit on their 2020 returns, which adds up to $1.7 billion total or about $186 per person.
How to claim a tax credit
Some tax credits, like the earned income credit, have specific lines on the 1040; your tax preparer will likely fill them out for you. For other tax credits, you may have to fill out a Schedule 3 form, then include the relevant amounts when filing your 1040.
You might have to submit other documents, too, depending on which credits you're eyeing: For the American opportunity credit, for instance, you'll need to complete Form 8863 and attach it to your 1040.
If you need help claiming a tax credit (or determining which you’re eligible for), consider consulting the IRS website or an accredited tax professional.
Latest tax credit news
It's been a busy few years for IRS tax credits.
In 2020 and 2021, the federal government sent out three rounds of stimulus checks to help people through the economic crisis triggered by the COVID-19 pandemic. These were advance payments of a refundable tax credit called the recovery rebate credit; as such, eligible Americans who didn't receive their stimulus checks upfront could claim the credit on their tax returns in 2021 and 2022. Congress also expanded the child tax credit, as mentioned above.
For now, there is no recovery rebate or expanded child tax credit on the horizon. The IRS is currently focused on working out the kinks in the tax credits for clean vehicles and employee retention.