What is a Tax Credit and How Does it Work?

Tax credits are a type of tax benefit that lower your income tax bill and, in some cases, increase your tax refund. There are several different tax credits available to taxpayers. Each tax credit has a unique set of qualifications, and the amount you can receive for a credit may be fixed, or it may depend on factors like income and number of dependents. 

How does a tax credit work? 

Let’s say you owe $2,000 for federal income taxes and you claim a $1,000 tax credit. The tax credit reduces your tax bill dollar for dollar. So now, instead of having a liability of $2,000, you owe $1,000.  

$2,000 (tax bill) – $1,000 (tax credit) = $1,000 (remaining balance

Can a tax credit increase your refund? 

If a tax credit is refundable, it can increase your refund. Refundable credits lower your tax bill, just like the example described above. And, if your liability goes to $0 or you don’t owe anything at all, the remaining credit balance comes back to you in your refund.  

Common U.S. tax credits 

Credit Amount Refundable? 
2021 Expanded Child Tax CreditUp to $3,600 per child under age 6, and up to $3,000 per child age 6-17Yes
Child Tax Credit Up to $2,000 per childPartially refundable up to $1,400 
Credit for other dependents $500 per dependent No 
American Opportunity Tax Credit Up to $2,500 per year for four years Partially refundable up to $1,000 
Lifetime Learning Credit Up to $2,000 for unlimited years No 
Child and Dependent Care Credit Up to $8,000 per child or $16,000 for two or more dependents  Yes
The Retirement Contribution Savings Credit 50%, 20%, or 10% of your contribution No 
Earned Income Tax Credit (EITC/EIC) Up to $6,660  Yes 

What makes a tax credit different from a tax deduction? 

Tax deductions are used to reduce your taxable income. Your taxable income is what is used to calculate your tax bill. Once your tax bill is calculated, tax credits can reduce the amount you owe. 

Read also: What are tax credits and tax deductions? 

How do I claim tax credits? 

When you file your taxes using TaxSlayer, we help you find the credits (and deductions) you are eligible to claim. You enter your personal info, your income and expenses, and TaxSlayer does the rest. Create your TaxSlayer account now and start filing for free! 

This article is intended to provide general information to the public and does not provide personalized tax, investment, legal, or business advice. You should seek the assistance of a professional for advice on taxes, investments, and any other financial, legal, or business matter pertinent to your individual situation.

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