All tax credits fall under two major categories: refundable and nonrefundable. For anyone keeping score, refundable is much better. It means that if the amount of the tax credit exceeds the taxes you owe, it will be added directly to your refund.
Say you owe $2,000 in taxes and have a $1,000 tax credit. Your tax bill would be reduced to $1,000. If you don't owe any taxes and have a $1,000 tax credit, you get a $1,000 tax refund. That's the kind of government incentive program anyone can get behind.
Nonrefundable tax credits can reduce the amount you owe, but any excess credit will not be refunded. That means if you owe $1,000 in taxes and have a $2,000 tax credit, your tax bill drops to zero but you don't get to keep the remaining $1,000.
Eligibility for tax credits varies, depending on the tax credit type and how much you earn. Credits are primarily available to low- and middle-income taxpayers with adjusted gross incomes up to about $50,000. While there are some exceptions, tax credit opportunities drop significantly for people who make much more than that [source: Intuit Turbo Tax].
Take a look at some of the most common types of federal tax credits and who qualifies:
Earned Income Tax Credit – This refundable tax credit is designed to help lower income workers. You may qualify if your adjusted gross income was $52,000 or less over the past year and you have children younger than 19 (or younger than 24 if they're still in school). Individuals and families with three or more children could qualify for a maximum credit of $6,143 for 2014. The average amount taxpayers received in 2013, thanks to the Earned Income Tax Credit, was $2,335 [source: IRS].
Child Tax Credit – Who said your kids never gave you anything? Parents can take advantage of this tax credit, which can cut $1,000 in federal tax for each dependent child under 17 who is a U.S. citizen. Full, nonrefundable credit is available to individuals making less than $75,000 or families making less than $110,000 in modified adjusted gross income. The amount of the credit starts to decrease or "phase out" for taxpayers with incomes higher than that [source: IRS].
Child and Dependent Care Credit – For working parents, this tax credit can help cover the cost of care for dependents or children age 13 or younger. This includes day care, summer camp and nursery school. The credit could pay you back up to 35 percent of $3,000 in annual expenses for one child, or up to 35 percent of $6,000 in expenses for two or more children. That means you could get between $1,050 and $2,100 in refundable credits. The percentage depends on your adjusted gross income. If you earn more than $43,000, you might qualify for 20 percent of expenses [source: Bell].
Retirement Savings Contributions Credit – Also known as the Saver's Credit, this nonrefundable credit gives back a portion of the contributions you make to a qualified 401(k) or individual retirement account — up to $2,000 for singles or $4,000 for married couples filing jointly. Eligibility is limited to those with adjusted gross incomes of less than $36,500 [source: IRS].
Lifetime Learning Tax Credit – Interested in taking a class that might help you on the job or prepare you for something new? This education credit, which is nonrefundable, can help pay for up to $2,000 of the cost of education or training for you, a spouse, a child or a dependent. You do not have to be enrolled in college to qualify for this credit.
American Opportunity Tax Credit – Different from the Lifetime Learning Credit, this is an education credit that helps pay for the first four years of college tuition, books or other supplies for each student in the household. Eligible students must be enrolled in school and pursuing a degree. The maximum credit amount is $2,500, and up to $1,000 (or 40 percent) of that is refundable. Generally, you can claim this credit if your adjusted gross income is less than $80,000 as a single filer, or $160,000 or less for joint filers. Students with felony drug convictions do not qualify [source: IRS].
Premium Tax Credit – This new refundable credit was introduced in 2014 as part of the Affordable Care Act (aka Obamacare). It's designed to help you pay for insurance purchased through a federal or state Health Insurance Marketplace. When you apply for insurance on a government exchange, you get an estimated annual credit amount. You can choose to have this amount paid directly to the insurance company, or you can pay it and get the credit back when you file your taxes. Like a lot of things related to the Affordable Care Act, eligibility requirements are complicated. Generally, your household income must be between 100 percent and 400 percent of the federal poverty line to qualify [source: IRS].
Residential Renewal Energy Tax Credit – Homeowners thinking of adding solar, geothermal, wind or fuel cell technology to their residential energy or heating systems might qualify for a federal tax credit to help pay for it. The credit is worth up to 30 percent of the cost to install the energy system [source: U.S. Department of Energy].
Adoption Tax Credit – For parents adopting a child younger than 18, there's a one-time, nonrefundable credit available from the federal government. In 2014, it's worth $13,190 per child, and the eligibility limits are high. You can claim full credit if your combined income is less than $197,880 and partial credit if you earn up to $237,880 [source: North American Council on Adoptable Children].
