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.
Common Types of Tax Credit
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].
State, Regional and Other Tax Credits
If the number of federal tax credits is not enough to think about, there are also state and local tax credits to consider. While credit amounts and eligibility vary by state, this overview can give you something to consider — or to discuss with an accountant.
State Earned Income Tax Credits – Similar to the federal EITC, refundable credits are available for earned income and offered in 21 states — including New York, Illinois, Colorado and Minnesota — in addition to Washington, D.C. Nonrefundable EITCs are offered in Virginia, Ohio, Delaware and Maine. Eligibility varies by state, so check with your state government website or tax accountant for more information.
New York City also offers its own refundable EITC. If you're a married couple with children and you earn less than $52,000, you can qualify for a credit of more than $8,000 [source: New York City Department of Consumer Affairs].
Homebuyer credits – Designed to encourage homeownership and stabilize the real estate market, homebuyer credits can help lower the cost of buying a house. One federal tax credit offered first-time homebuyers up to 10 percent of the purchase price of a home purchased between April 2008 and May 2010. That credit has since expired, but many states still offer credits and other assistance programs to encourage would-be buyers. Homeownership.org can help you find programs in your state.
Energy tax credits – Depending on your state or region, local government agencies and utility companies might offer valuable credits when you invest in energy efficiency. Energy.gov lets you search for the programs offered in your state.
There's a Tax Credit for That?
Sometimes, the stars align and give you a tax break for something really cool — like an electric car. Before hybrid cars became popular with consumers, the federal government offered a tax credit for buying one. Those credits are gone, but if you're in the market for an electric car or plug-in hybrid, there's a nonrefundable credit for that. It's worth about $7,500 if the car meets eligibility requirements [source: Halvorson].
If you've always wanted to rehab an old building to create a business or income-producing historic property, the federal Historic Rehabilitation Tax Credit can cover up to 20 percent of the qualifying expenses. Even if the building is not necessarily historic, but built before 1936, you can get up to 10 percent of the cost to restore it [source: National Park Service].
Tax credits could even help you become a movie star without ever stepping onto a Greyhound bus to Hollywood. Many states use tax credit incentives to lure film productions away from southern California. New York, Louisiana and North Carolina are among the states with booming film industries because of tax credits. Even the Brits are taking advantage — an outpost of England's Pinewood Studios is being built in Georgia.
There's debate over whether these "credits" actually work. They're expensive for states and work differently than other tax credits. Companies can get the money even if they don't file taxes in the state offering the credits. But they also bring jobs to local production crews, caterers and electricians. Meanwhile, California is fighting back with even more aggressive credits to help keep the tinsel in Tinseltown [source: Verrier].
Keep in mind that these credits can be complicated, so before you run out to make a purchase or start a film production company, check with a tax accountant to verify the program is right for you.
Author's Note: How Tax Credits Work
I like to think of myself as someone with a keen eye for tax savings, especially those that my accountant tells me about. But before I reported this story, I had no idea just how many tax credit opportunities are available to U.S. taxpayers. You just need to know where to look. Now excuse me while I indulge my "Gilmore Girls" fantasy of finding a Dragonfly Inn-type historical bed and breakfast to restore (complete with green energy, of course) on the government's dime.
- Avalos, Antonio and Sean Alley. "Left on the Table." New American Foundation. March 9, 2010. (Nov. 4, 2014) http://www.newamerica.net/publications/policy/left_on_the_table
- Bell, Kay. "IRS Can Help You Look After the Kids." Bankrate. March 5, 2012. (Nov. 4, 2014) http://www.bankrate.com/finance/money-guides/irs-helps-with-the-kids-1.aspx
- Halvorson, Bengt. "Federal Tax Credits for Plug-In Hybrids, Electric Cars: What You Need to Know." The Washington Post. Aug. 20, 2014. (Nov. 1, 2014) http://www.washingtonpost.com/cars/federal-tax-credits-for-plug-in-hybrids-electric-cars-what-you-need-to-know/2014/08/20/0ae02718-2886-11e4-8b10-7db129976abb_story.html
- Internal Revenue Service. "American Opportunity Tax Credit: Questions and Answers." Sept. 23, 2014. (Oct. 30, 2014) http://www.irs.gov/uac/American-Opportunity-Tax-Credit:-Questions-and-Answers
- Internal Revenue Service. "Check Your Eligibility for the Earned Income Tax Credit." Jan. 25, 2013. (Oct. 30, 2014) http://www.irs.gov/uac/Check-Your-Eligibility-for-the-Earned-Income-Tax-Credit
- Internal Revenue Service. "EITC and Other Refundable Credits." March 27, 2014. (Oct. 30, 2014) http://www.eitc.irs.gov/EITC-Central/abouteitc
- Internal Revenue Service. "IRS Seeks to Return $153 Million in Undelivered Checks to Taxpayers; Recommends e-file, Direct Deposit to Avoid Future Delivery Problems." March 13, 2014. (Nov. 4, 2014) http://www.irs.gov/uac/IRS-Seeks-to-Return-$153-Million-in-Undelivered-Checks-to-Taxpayers%3B-Recommends-e-file,-Direct-Deposit-to-Avoid-Future-Delivery-Problems
- Internal Revenue Service. "Questions and Answers on the Premium Tax Credit." Oct. 1, 2014. (Oct. 30, 2014) http://www.irs.gov/uac/Newsroom/Questions-and-Answers-on-the-Premium-Tax-Credit
- Internal Revenue Service. "Retirement Savings Contributions Credit (Saver's Credit)." Oct. 23, 2014. (Nov. 4, 2014) http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Retirement-Savings-Contributions-Credit-(Saver's-Credit)
- Internal Revenue Service. "Ten Facts About the Child Tax Credit." Feb. 10, 2011. (Nov. 4, 2014) http://www.irs.gov/uac/Ten-Facts-about-the-Child-Tax-Credit
- Intuit Turbo Tax. "The 5 Biggest Tax Credits You Might Qualify For." 2014. (Oct. 30, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Tax-Deductions-and-Credits/The-5-Biggest-Tax-Credits-You-Might-Qualify-For/INF18200.html
- Intuit Turbo Tax. "What Are Tax Credits?" 2014. (Nov. 4, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Taxes-101/What-Are-Tax-Credits-/INF14393.html
- National Park Service. "Historic Presentation Tax Incentives." 2012. (Nov. 1, 2014) http://www.nps.gov/tps/tax-incentives/taxdocs/about-tax-incentives-2012.pdf
- New York City Department of Consumer Affairs. "Tax Credit Campaign: Earned Income Tax Credit." (Nov. 4, 2014) http://www.nyc.gov/html/ofe/html/policy_and_programs/eitc.shtml
- North American Council on Adoptable Children. "Claiming the Federal Adoption Tax Credit for 2014." April 2014. (Nov. 1, 2014) http://www.nacac.org/taxcredit/taxcredit2014.html
- U.S. Department of Energy. "Residential Renewable Energy Tax Credit Program Info." (Nov. 4, 2014) http://energy.gov/savings/residential-renewable-energy-tax-credit
- Verrier, Richard. "Are Film Tax Credits Cost Effective?" Los Angeles Times. Aug. 30, 2014. (Nov. 1, 2014) http://www.latimes.com/entertainment/envelope/cotown/la-et-ct-fi-film-tax-credits-20140831-story.html#page=1