Tax preparers often encounter clients who are confused about the various tax credits available to them. Understanding these credits can significantly impact your tax liability and, in some cases, result in a refund. This article aims to demystify individual tax credits, explain the difference between refundable and non-refundable credits, and discuss credit carryovers. By the end, you should have a clearer understanding of how to leverage these credits to your advantage.
What Are Tax Credits? Tax credits are amounts that reduce the tax you owe on a dollar-for-dollar basis. Unlike deductions, which lower your taxable income, tax credits directly reduce the amount of tax you owe. There are two main types of tax credits: refundable and non-refundable.
Refundable vs. Non-Refundable Tax Credits
Refundable Tax Credits: These credits can reduce your tax liability to zero and result in a refund if the credit amount exceeds your tax liability. In other words, if your tax liability is $400 and you have a refundable credit of $1,000, you will receive a $600 refund. This is where many individuals who are not required to file a tax return miss out on substantial refundable tax credits intended for those with low incomes.
Non-Refundable Tax Credits: These credits can reduce your tax liability to zero but cannot result in a refund. If your tax liability is $400 and you have a non-refundable credit of $1,000, your tax liability will be reduced to zero, but you will not receive a refund for the remaining $600.
Credit Carryovers - Some non-refundable credits come with carryover provisions, allowing you to apply any unused portion of the credit to future tax years. This can be particularly beneficial if you have a low tax liability in the current year but expect higher liabilities in future years.
Common Individual Tax Credits - Let's delve into some of the most common individual tax credits, indicating whether they are refundable or non-refundable and if they include carryover provisions.
Earned Income Tax Credit (EITC) - The Earned Income Tax Credit (EITC) is designed to benefit low to moderate-income working individuals and families. The credit amount varies based on your income and the number of qualifying children you have. For the 2024 tax year, the maximum credit is $7,830. Type: Refundable
Child Tax Credit (CTC) - The Child Tax Credit (CTC) provides up to $2,000 per qualifying child under the age of 17. Up to $1,400 of this credit is refundable, meaning you can receive a refund even if you do not owe any tax. The refundable portion is known as the Additional Child Tax Credit (ACTC). Type: Partially Refundable
American Opportunity Tax Credit (AOTC) - The American Opportunity Tax Credit (AOTC) is available for the first four years of post-secondary education. The maximum credit is $2,500 per eligible student, with 40% of the credit (up to $1,000) being refundable. The credit covers tuition, fees, and course materials. Type: Partially Refundable
Lifetime Learning Credit (LLC) - The Lifetime Learning Credit (LLC) provides up to $2,000 per tax return for qualified higher-education expenses. Unlike the AOTC, the LLC is non-refundable, meaning it can reduce your tax liability to zero but will not result in a refund. There is no limit on the number of years you can claim this credit. Type: Non-Refundable
Saver’s Credit - The Saver’s Credit is designed to encourage low to moderate-income individuals to save for retirement. The credit is worth up to $1,000 ($2,000 for married couples filing jointly) and is non-refundable. It can be claimed for contributions to retirement accounts such as IRAs and 401(k)s. Type: Non-Refundable
Child and Dependent Care Credit - The Child and Dependent Care Credit helps offset the cost of childcare or care for a dependent while you work or look for work. The credit is worth up to 35% of qualifying expenses, with a maximum of $3,000 for one qualifying individual or $6,000 for two or more. Type: Non-Refundable
Adoption Credit - The Adoption Credit provides financial assistance for qualified adoption expenses. For the 2024 tax year, the maximum credit is $16,810 per child. This credit is non-refundable but can be carried forward for up to five years if the credit exceeds your tax liability. Type: Non-Refundable with Carryover
Residential Clean Energy Credit - The Residential Clean Energy Credit is available for the installation of qualified energy-efficient improvements, such as solar panels and solar water heaters. The credit is worth 30% of the cost of the improvements and is non-refundable. Unused portions of the credit can be carried forward to future tax years. Type: Non-Refundable with Carryover
Premium Tax Credit (PTC) - The PTC helps eligible individuals and families cover the cost of premiums for health insurance purchased through a government Health Insurance Marketplace. The credit amount is based on your family income and the cost of the premiums. This credit is refundable, meaning you can receive a refund if the credit exceeds your tax liability. Type: Refundable
New Clean Vehicle Credit - Commonly referred to as the Electric Vehicle (EV) Credit, the New Clean Vehicle Credit is available for the purchase of qualifying all electric, plug-in hybrid, and fuel cell vehicles. Limits apply based your income and the manufacturer’s suggested retail price of the vehicle. The credit amount varies based on the vehicle's battery capacity but can be up to $7,500. In lieu of claiming the credit on your tax return, you may be able to transfer the credit to the dealer at the time of purchase, which could reduce the vehicle’s cost or your down payment. Type: Non-Refundable with no carryover
Previously Owned Clean Vehicle (EV) Credit - The Previously Owned Clean Vehicle Credit is designed to incentivize the purchase of used electric vehicles. The credit is up to $4,000 or 30% of the vehicle's price, whichever is less. As with the New Clean Vehicle credit, there are caps on the income of the purchaser and the cost of the vehicle, but the amounts are different. This credit is non-refundable with no carryover. Type: Non-Refundable with no carryover
Credit for the Elderly or Disabled - The Credit for the Elderly or Disabled is available to low income individuals who are 65 or older or who are retired on permanent and total disability. The maximum credit is $7,500, but it is non-refundable, meaning it can only reduce your tax liability to zero. Type: Non-Refundable
Foreign Tax Credit - The Foreign Tax Credit is available to individuals who pay taxes to a foreign government on income that is also subject to U.S. tax. This credit is non-refundable but can be carried back one year and forward up to ten years if it exceeds your tax liability. Type: Non-Refundable with Carryover
General Business Credit - The General Business Credit is a collection of various credits available to businesses, including sole proprietorships, that are passed through to the individual. These credits are non-refundable but can be carried back one year and forward up to twenty years. Type: Non-Refundable with Carryover
Our goal is to help you navigate the complexities of the tax code and maximize your tax benefits. If you have any questions or need assistance with your tax return, please do not hesitate to contact us. Together, we can ensure you take full advantage of the tax credits available to you.
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