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How Tax Credits Work

        Money | Taxes

Are you taking full advantage of all the tax credits out there? If not, you might be letting money slip away.
Are you taking full advantage of all the tax credits out there? If not, you might be letting money slip away.
Salvador Burciaga/Hemera/Thinkstock

Regardless of how much we earn, which politicians we support or what type of music we like to listen to, the one thing that unites pretty much all Americans is the desire for a lower tax bill. Tax credits are one way to make that happen.

Tax credits can reduce the amount you owe each year in federal, state and sometimes even local income taxes. Different from tax deductions, which lower your taxable income, tax credits can actually shave dollars off your tax bill. They might even result in a hefty refund. This makes tax credits extremely valuable to those who qualify.

Think of tax credits as a type of government incentive program to reward people for making good decisions, like going to college, saving for retirement or using clean energy [source: Intuit Turbo Tax]. There's even a tax credit for simply going to work and earning income. There's also a credit for raising children, and another for adopting them. And if those kids make going to work a challenge, there's a tax credit to help cover the cost of day care.

Unfortunately, these credits are sometimes overlooked by income-tax filers. Even if you skip your annual income taxes because your earnings aren't significant, you might be missing out on a credit you deserve. For example, one in five eligible taxpayers don't claim the Earned Income Tax Credit, which could potentially result in a refund of about $6,000 [source: IRS].

One report found that taxpayers in California alone were missing out on more than $1.2 billion by not filing [source: Avalos and Alley]. Even among those Americans who do file, more than $153 million in refund checks go unclaimed or undelivered [source: IRS]. The IRS gives you three years to claim what you are owed. After that, your cash belongs to the U.S. Treasury.

Next, let's look into the different types of tax credits.


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