What are tax credits?
Tax credits reduce your tax liability. The IRS offers several tax credit categories, including family and dependents, income and savings, homeowners, healthcare, and education tax credits. If you qualify for a given tax credit, you can subtract it from your total tax load, keeping more money in your pocket.
Types of tax credits
You will find three types of tax credits: refundable, non-refundable, and semi-refundable.
- Refundable: If a credit is refundable, that means that if the credit reduces your tax liability to less than zero, you’ll receive the surplus in your tax refund.
- Semi-refundable: Semi-refundable credits allow for a portion of the total credit amount to be refunded (when applicable).
- Nonrefundable: Non-refundable credits can only reduce your tax owed to zero. Beyond that, the balance is null.
Still confused? Let’s take a look at an example.
Say you owe $5,000 in taxes for the year, but you qualify for $7,000 in refundable tax credits. You would end up owing nothing and receiving a tax refund of $2,000.
If, on the other hand, the tax credits were non-refundable, you still wouldn’t owe anything, but you also wouldn’t get a refund.
And if the tax credits were semi-refundable ($6,000 refundable and $1,000 not), you would end up with a $1,000 refund.
Tax credits vs. tax deductions
Both tax credits and tax deductions can save you money, but they do so differently. You subtract deductions from your taxable income before calculating the amount of tax you owe. Tax credits, on the other hand, are applied after your tax liability has been determined.
So what tax credits are available to you this year? The tax credits available change often. The list below provides the top tax credits available for the 2020 tax year, but these tax preparation companies can help you make sure you are not missing out on any new tax credits.
Let’s look at the top tax credits that can save you money by category.
Family-related tax credits
Earned Income Tax Credit (EITC)
The Earned Income tax credit (also known as EITC) is a refundable tax credit designed for people with low-to-moderate income. To qualify, you must file a tax return and have earned income from an employer or farm. Additionally, you must either have a child that meets all the qualifying rules or meet the additional rules for workers without a qualifying child.
Here’s a look at the income limits for 2018:
|If filing…||Qualifying Children Claimed|
|Zero||One||Two||Three or more|
|Single, Head of Household, or Widowed||$15,820||$41,756||$47,440||$50,594|
|Married Couple Filing Jointly||$21,710||$47,646||$53,330||$56,844|
Additionally, you can’t earn more than $3,650 in investment income for the year.
The maximum credit amounts for 2020 were as follows:
- $6,660 with three or more qualifying children.
- $5,920 with two qualifying children.
- $3,584 with one qualifying child.
- $538 with no qualifying children.
What are the child qualification requirements for the EITC? The child in question must:
- Be the taxpayer’s son, daughter, adopted child, foster child, stepchild, sibling, half-sibling, step-sibling, or descendant of any of the aforementioned.
- Have a valid social security number.
- Live with you within the U.S. for more than six months.
- Be younger than you (or your spouse, if filing a joint return) and under the age of 19, unless they are a full-time student (age limit is 24) or fully disabled (no age limit).
Child and Dependent Care Credit
The Child and Dependent Care Credit can cover up to 35% (up to $3,000 per dependent, $6,000 max) of a carer’s costs for your dependent.
The dependent must be a child under the age of 13 or a dependent or spouse of any age who is incapacitated. Further, to claim this credit, you must have paid for your dependent’s care to work or look for work. Also, you must have earned income during the applicable tax year.
How much you can get from the Child and Dependent Care depends on your income. If your income is less than $15,000, you can get the full credit equal to 35% of your expenses for every $2,000 of income above $15,000. The percentage drops by one point, to a minimum of 20% (if you make over $43,000).
Qualifying expenses include but are not limited to:
- Nursery school, preschool, or similar programs.
- Before- or after-school care.
- Household services that include caring for the qualifying person.
Note that if you pay for this care using a dependent-care flexible spending account or similar program with tax benefits, this can reduce your credit.
Child Tax Credit (CTC)
The Child Tax Credit is a semi-refundable credit of up to $2,000 per qualifying child and $500 per non-child dependent. As of 2020, $1,400 of the CTC was refundable.
This credit is for individuals with qualifying children who they can claim as dependents. Note that if your income exceeds $200,000 (or $400,000 for married filed jointly), the credit amount is reduced.
For a child to qualify, they must:
- Be your son, daughter, stepchild, foster child, sibling, step-sibling, half-sibling, or descendant of any of the above.
- Be under the age of 17 during.
- Depend on you for over half of their support.
- Live with you for over half of the year.
- Be claimed as a dependent on your return.
- Be a U.S. citizen, national, or resident alien with a social security number.
This helps to compensate you for the costs you incur as part of caring for a dependent.
The Adoption Credit is for taxpayers who adopt a child in a qualifying situation. For the 2020 tax year, the credit covers up to $14,300 of the costs.
Note that you can’t take the credit if the child in question is your spouse’s child. If you adopt a child with special needs, you can take the full credit amount even if your expenses cost you less than $13,810.
Additionally, this credit is subject to reduction or elimination based on your income. In 2020, the credit began to be reduced if your modified adjusted gross income (MAGI) was over $214,520. For taxpayers with a MAGI above $254,520, the credit is eliminated.
Education Tax Credits
American Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit (also known as AOTC) is a semi-refundable tax credit that helps to cover the qualifying costs of an eligible student’s first four years of higher education. The maximum amount that you can get is $2,500 per eligible student. And if the credit brings your tax liability to zero, only 40% of the credit is refundable (up to $1,000).
Student eligibility requirements for the AOTC:
- At least half-time enrollment for one academic period that starts in the tax year.
- Pursuing a recognized educational credential or degree.
- Has not completed the first four years of higher education at the start of the tax year.
- Has not claimed the AOTC (or Hope credit) for more than four tax years.
- No felony drug convictions at any time during the year.
- Must have received Form 1098-T from an eligible institution.
- Needs a valid taxpayer identification number.
Income limits also apply to those claiming the AOTC. These limits are as follows:
- If your MAGI is $80,000 or less ($160,000 or less for married filing jointly), you’re eligible for the full credit.
- If you make more than $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly), you’re eligible for a partial credit.
- And if you make more than $90,000 ($180,000 for joint filers), you’re ineligible for this credit.
Lifetime Learning Credit (LLC)
The Lifetime Learning Credit (also known as LLC) is a non-refundable credit to help pay for undergraduate, graduate, and professional degree courses for eligible students attending eligible institutions. It can refund 20% of the first $10,000 (up to $2,000) of qualified expenses paid by you, your dependent, or a third party. There is no limit on how many years you can claim this credit.
Student eligibility requirements for the Lifetime Learning Credit
The eligible student must be:
- You, your spouse, or a dependent listed on your tax return.
- Pursuing a degree or recognized educational credential.
- Enrolled for a minimum of one academic period starting in the tax year.
- Attending an eligible institution.
- The recipient of Form 1098-T.
Income limits apply as follows:
- Eligible for full credit: If you make less than $59,000 if your filing status is single ($118,000 for married couples).
- Eligible for partial credit: If you make between $59,000 and $69,000 ($118,000 and $138,000 if you file a joint return).
- Ineligible: If you make more than $69,000 ($138,000 or more if you file a joint return).
Income and savings-related
Saver’s Tax Credit
The saver’s credit, aka the Retirement Savings Contributions Credit, is a non-refundable tax credit that reimburses you for a percentage of your contributions to an employer-sponsored retirement plan or an IRA (traditional and/or Roth).
The credit will be 10%, 20%, or 50% of your eligible contribution amount, depending on your contributions, adjusted gross income, and tax filing status. However, the credit is capped at $2,000 (or $4,000 if you file jointly with your spouse).
- At least 18 years old.
- Not a full-time student.
- Not a dependent.
- AGI less than $33,000 if your filing status is single ($66,000 if married and filing jointly)
This is a great incentive to save for retirement.
Foreign Tax Credit
As our world becomes more connected, more and more people are living and working abroad. The Foreign Tax Credit allows you to claim a credit to cover the cost of income taxes imposed on you by a foreign country. However, you can’t take this credit if you exclude foreign earned income or foreign housing costs.
The tax credit maximum is calculated by determining the percentage of your total income that the foreign income accounts for and then multiplying that percentage by your U.S. tax liability. For example, if you made $100,000 in the U.S. and $25,000 in Mexico, 20% of your income would be foreign. If your U.S. tax liability was $10,000, you could take a foreign tax credit of $2,000 (20% of $10,000).
If the credit doesn’t cover the full amount of foreign taxes you paid, you may be able to carry them back one tax year or forward 10 tax years.
Residential Energy Credit
The Residential Energy Credit helps to reimburse you for investments in solar energy systems like solar panels or solar water heaters. You can get a credit for up to 30% of what you spent on renewable energy systems.
Plug-in Electric-Drive Motor Vehicle Credit
The Plug-in Electric-Drive Motor Vehicle Credit can earn you a credit from $2,500 to $7,500, depending on the vehicle’s battery capacity. To qualify, you must buy a plug-in electric vehicle with at least four wheels, primarily propelled by a rechargeable battery. Also, that battery must allow for at least four kilowatt-hours.
Maximize your tax credits and savings
Tax credits and tax deductions are put in place to incentivize certain behaviors and provide tax relief to those in need. To ensure that you take advantage of all of the savings you qualify for, consider hiring a tax preparation expert. You have many options both on and offline, making it easy and convenient to get help with your tex return. Review and compare industry-leading tax prep firms below, complete with reviews from real people. Investing in an expert can save you many times over, not just in money but also in your time and energy.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.