Tax credits are a type of tax benefit that lowers your income tax bill dollar-for- dollar and, in some cases, can 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. In some cases, credits cover expenses you pay during the year, but all have requirements you must meet before you can claim them.
How do tax credits work?
A tax credit reduces your taxable income dollar-for-dollar. For example, 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)
What is a state tax credit?
A state tax credit reduces the state income tax you owe. You only qualify if you’re filing a return in that state. These credits encourage actions like making energy-efficient upgrades to your home or helping working families with childcare. Each state has its own credits with different rules and amounts.
For example, California offers the California Earned Income Tax Credit (CalEITC), which provides a credit for low-income working families. To qualify, you must reside in California and meet specific income requirements.
In contrast, federal tax credits are the same across all states. An example is the Earned Income Tax Credit (EITC), which benefits low to moderate-income working individuals and families. Unlike state credits, any qualifying U.S. taxpayer can claim the federal EITC, regardless of which state they reside in.
Types of tax credits
Tax credits can generally be placed into three categories: refundable, nonrefundable, and partially refundable credits.
Refundable tax credits
Refundable tax credits allow taxpayers to receive a refund if the credit exceeds their tax liability. Let’s say your tax bill is $800, and you qualify for a refundable tax credit of $1,200, you apply the credit to reduce your tax owed to $0. You receive a refund of $400 since the credit exceeds your tax bill.
$800 (tax bill) + $1,200 (tax credit) = $400 (refund)
The most common refundable tax credits are the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC). The EITC is a tax break intended to benefit low-to-moderate income earners, while the ACTC is the portion of the Child Tax Credit that is refundable.
Non-refundable tax credits
Nonrefundable tax credits can reduce your liability to zero but if the amount of the credit exceeds the tax owed, the excess won’t be refunded to you. Some examples of nonrefundable tax credits include:
- Child tax credit (CTC)
- Credit for other dependents (ODC)
- Adoption credit
- Lifetime learning credit (LLC)
- Saver’s credit
- Child and dependent care tax credit.
- Foreign tax credit.
Partially refundable tax credits
A partially refundable tax credit is a type of tax credit that allows you to receive a refund for a portion of the credit amount, even if your tax liability is lower than the total credit. In other words, while not all of the credit is refundable, a certain percentage or amount can be paid out as a refund.
The American Opportunity Tax Credit (AOTC) is a partially refundable tax credit for education expenses, allowing a maximum of $2,500 per eligible student. If the credit exceeds your tax liability, you can receive up to $1,000 as a refund. This means if you owe less than $1,500 in taxes, you could still get that refund portion.
Common tax credits
Tax credits play an important role in reducing the financial burden of education and other expenses for individuals and families. This table provides an overview of common tax credits, maximum benefits, and any refundable portions.
| Credit | Amount | Refundable? |
| 2021 Expanded Child Tax Credit | Up to $3,600 per child under age 6, and up to $3,000 per child age 6-17 | Yes |
| Child Tax Credit | Up to $2,000 per child | Partially refundable up to $1,700 |
| 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 $7,830 | Yes |
What’s the difference between tax credits and tax deductions?
Tax credits and tax deductions are different types of tax relief. Both can lower your tax bill, but they function in unique ways. 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. For example, if you owe $3,000 in taxes and qualify for a $1,000 tax credit, your tax bill is reduced to $2,000. On the other hand, if you have a taxable income of $50,000 and claim a $1,000 deduction, your new taxable income is $49,000. The actual tax savings from a deduction depend on your tax rate. If you’re in a 20% tax bracket, that $1,000 deduction would save you $200 in taxes (20% of $1,000).
Who qualifies for tax credits?
Eligibility requirements for tax credits can vary depending on the specific credit, but generally include factors such as income level, filing status, age, and residency. Many tax credits are income-based and are designed for low- to moderate-income taxpayers, so individuals with incomes exceeding certain thresholds may not qualify.
How do I claim tax credits?
To claim a tax credit, check your eligibility and gather documentation like receipts. If you were filing on paper, you’d complete the relevant tax form, calculate the credit amount as instructed, then enter that amount on your tax return. When you file your taxes using TaxSlayer, we help you find the credits (and deductions) you are eligible to claim. Simply follow the prompts to enter your personal info, income, and expenses, and TaxSlayer does the rest. Create your TaxSlayer account now and start filing for free!
