Income tax credits are typically better than income tax deductions. Deductions only reduce the amount of income you have to pay taxes on. Credits reduce your tax bill directly. In some cases, the Internal Revenue Service (IRS) might even pay you. Not everyone qualifies for income tax credits and the rules can be complicated. Make sure that you are eligible for any credits taken on your income tax return.
Credits Reduce the Tax You Owe
When you complete your income tax return, you calculate the income tax you owe the IRS. This amount may be reduced by any self-employment taxes you paid or what your employer deducted from your paychecks all year. The amount of your total tax is eligible for credits, and tax credits apply directly to this amount. Suppose you owe the IRS $750 for the year. If your employer withheld $100, and if you're eligible for a $500 tax credit, you only have to pay $150.
Some Credits Are Refundable
The IRS offers two kinds of tax credits: refundable and non-refundable. With refundable tax credits, if the IRS eliminates your entire tax bill and there's still some credit left over, the IRS will refund the balance to you. If you owe the IRS $750 and your employer withheld $100, and if you're eligible for a $1,000 refundable credit, the IRS will send you a check for $350. Non-refundable credits can only eliminate your tax bill. If you're eligible for a $1,000 non-refundable credit, you wouldn't owe the IRS anything, but the IRS would keep the balance.
You Must Qualify for Credits
All tax credits have limitations. There's no one single credit that applies to everyone. For example, the IRS offers credits if you're paying college tuition for yourself or your dependents. However, you can only qualify for them if you earn less than a certain amount. Only taxpayers with earned income from wages or self-employment are eligible for the earned income tax credit. The amount of this credit depends on the number of children you have and a few other factors. You may be eligible for an income tax credit if you pay for child care for dependent children but only if you pay for child care in order to work or look for a job.
Some Choices Are Involved
Sometimes tax credits and tax deductions can overlap. For example, you can deduct tuition expenses from your income. If you use the deduction, however, you typically can't claim an education-related tax credit as well. You'd have to make a choice based on which option results in the most savings to you. Some income tax credits, such as the earned income tax credit, are only available to taxpayers who file Form 1040 or Form 1040A tax returns. Those who file a Form 1040EZ are not eligible for this credit.
A Tax Lawyer Can Help
The law surrounding the best use of income tax credits is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a tax lawyer.