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What Is a Tax Credit?

A tax credit is a reduction in the overall tax that a taxpayer owes to the government. Tax credits differ from deductions, although both have the end result of reducing the amount of taxes that a person must pay.

How Do Credits Lower Tax Liability?

Deductions decrease a person's adjusted gross income in order to arrive at that person's taxable income. Because the deductions reduce the amount of income that is subject to taxation, they have the effect of lessening a person's tax liability, which is done more indirectly.

Tax credits, on the other hand, diminish the amount of actual taxes that the person owes. For example, suppose a taxpayer can claim a $500 tax credit. The tax owed by the taxpayer based on their taxable income is $2,000. The tax credit will reduce the actual tax liability, so the taxpayer will end up owing the government only $1,500.

Refundable and Non-Refundable Tax Credits

There are two varieties of tax credit: refundable and non-refundable. If a tax credit is refundable, it means that the government will pay the taxpayer if the credit exceeds the amount of taxes owed. In other words, if a taxpayer can claim a tax credit of $750 but only has a tax liability of $500, the taxpayer can expect a tax refund of $250 since that is the amount of the credit that exceeds the taxpayer's tax liability. The Earned Income Tax Credit is a refundable credit.

Non-refundable tax credits, as the name suggests, can eliminate a taxpayer's liability but not exceed your tax liability. The taxpayer will not receive a tax refund from the government if the credit exceeds the amount of taxes owed.

Types of Tax Credits Available for Individual Taxpayers

There are many different tax credits available to taxpayers. Certain credits and deductions may only be available if you have income below a certain amount. Eligibility for credits may depend on your filing status, income, and other factors. Some of the most common tax credits for individuals include:

  • Advance Child Tax Credit Payments
  • Earned Income Tax Credit
  • Child and Dependent Care Credit
  • Saver's Credit
  • Residential Energy Efficient Property Credit
  • Health Coverage Tax Credit
  • American Opportunity Credit and Lifetime Learning Credit

Types of Tax Credits Available for Individual Taxpayers

Tax laws can be complicated, especially when you are unsure whether or not you qualify for tax credits and deductions. If you have questions about your eligibility for a tax credit, talk to your tax professional. If you need legal help dealing with the IRS or tax court, find a tax attorney in your area for advice.

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Next Steps

Contact a qualified tax attorney to help you navigate your federal and/or state tax issues.

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