Tax season is upon us, and if you want to reduce how much you pay the government, you need to understand which tax credits you can claim.
Credits are an efficient way to reduce a tax bill, but they can be misunderstood, says Nick Strain, senior wealth advisor with financial firm Halbert Hargrove in Long Beach, California. “Each one of these credits has their own (income) threshold,” he says. That means not every credit will be available to every household.
Keep reading to learn more about how tax credits differ from deductions and which federal tax credits apply to your situation.
What Is a Tax Credit?
Tax credits shouldn’t be confused with tax deductions. While a tax credit directly offsets taxes owed, a deduction reduces how much income is taxable.
“A tax credit is always more valuable than a deduction,” says Matt Schwartz, certified financial planner with Great Waters Financial in Minnetonka, Minnesota.
For instance, a $1,000 tax credit will wipe out $1,000 in taxes due. However, the value of a tax deduction depends on your tax bracket. For those in the 22% tax bracket, a $1,000 deduction will save $220 in taxes.
Some credits are refundable, which means they will result in a refund if the amount of the credit exceeds the amount of taxes owed. Other credits are nonrefundable and can wipe out a taxpayer’s bill but won’t result in a tax refund.
Because credits are so valuable, the government usually places income limits or other restrictions on who can claim them. These restrictions can vary for each credit. What’s more, both states and the federal government may offer credits for similar expenses, but each have their own eligibility criteria.
“A lot of people think they should be getting credits when they don’t know the rules of the credits,” says Abby Donnellan, senior tax strategist with financial firm Compardo, Wienstroer, Conrad & Janes in Clayton, Missouri.
Overall, the most common credits fall into the following categories: tax credits for college, tax credits for families, tax credits for income-eligible households and tax credits for investments.
Tax credits you may be qualified for include the following:
— American opportunity credit.
— Lifetime learning credit.
— Child tax credit.
— Child and dependent care tax credit.
— Adoption tax credit.
— Earned income tax credit.
— Premium tax credit.
— Recovery rebate credit
— Foreign tax credit.
— Retirement savings contribution credit.
Keep reading to learn more about these credits and who can claim them.
Tax Credits for College
American opportunity credit. Those paying college tuition have two tax credit options. The most lucrative is the American opportunity tax credit. Parents of dependent students, as well as independent students, may be eligible for a $2,500 per student credit for the first four years of undergraduate education. Of that, up to $1,000 is refundable.
To claim the credit, students must be enrolled at least half time for one academic period, be pursuing a degree or other recognized education credential and not have previously claimed an American opportunity credit or the former Hope credit for more than four tax years. Eligible expenses include tuition, fees and expenses that are required for attendance in class, such as books.
“It’s phased out at income levels that are relatively low,” Schwartz says. Only married couples filing jointly who have modified adjusted gross incomes of less than $180,000 can claim the credit; the income limit for those with other filing statuses is $90,000.
Lifetime learning credit. The lifetime learning credit is equal to 20% of qualified education expenses, up to a $2,000 credit per year. To be eligible, your modified adjusted gross income cannot exceed $138,000 as a married couple filing jointly or $69,000 as a single filer. There is no cap on how many years someone can receive a lifetime learning credit, and classes don’t have to be part of a degree program.
Tax Credits for Families
Child tax credit. The child tax credit underwent significant changes in 2021. The credit was increased from $2,000 to $3,000 for children ages 6-17 and $3,600 for children younger than age 6. Eligibility for the credit was also expanded, and the government sent out monthly payments during the second half of 2021 that were equal to half a household’s expected credit.
“Instead of being partially refundable as in the past, it’s fully refundable (for 2021),” Donnellan says.
Parents who received advance payments in 2021 will need to file a tax return to reconcile the payments they received with the amount they are owed. Those who are eligible for the full credit will have the remainder applied to their tax return. If someone received advanced payments and is not actually eligible for the credit, they may be able to keep the money depending on their income.
For 2022, the child tax credit reverts back to its previous level of $2,000 for each child younger than age 17 who lives with a taxpayer more than half the year. Married couples filing jointly can have incomes as high as $400,000 before their eligibility phases out, and other taxpayers can have incomes of up to $200,000 and receive the credit.
[Read: What Is the Child Tax Credit?]
Child and dependent care tax credit. The child and dependent care tax credit is another credit that got a boost in 2021. Normally, the maximum credit that can be received is 35% of $3,000 in allowable expenses for a single child or $6,000 in allowable expenses for two or more children. However, for 2021 only, the credit can be claimed on up to $8,000 of qualifying expenses for one child and $16,000 of expenses for two or more children.
This credit is available to those who pay for child care so they can work. Qualifying expenses include care for children younger than age 13, spouses who are physically or mentally incapable of self-care or other qualifying individuals who are incapable of self-care. In all cases, the person receiving care must live with the taxpayer for more than half the year.
Adoption credit. This credit can help reimburse parents for their legal fees and other costs associated with adoption. In addition to a credit of $14,400 for a qualified adoption, taxpayers may be able to exclude $14,400 from their income in 2021 if an employer pays for qualifying expenses. However, the credit and the exclusion can’t be for the same adoption costs.
You’ll need a modified adjusted gross income of $216,660 or less in 2021 to receive the complete credit and exclusion. After that, your tax benefits are reduced and then eliminated once your income hits $256,660. The credit is nonrefundable, but you can carry over any unused portion of the credit for up to five years.
Tax Credits for Income-Eligible Households
Earned income tax credit. The earned income tax credit can be lucrative for those who qualify. “I think that one gets overlooked a lot,” Donnellan says. That may be because it is specifically for low- and moderate-income earners, which limits who can claim it.
The maximum credit for 2021 is $6,728 for a household with three or more qualifying children, but it can vary. “It depends on your income and the number of children you have,” Strain says.
Income limits range from $21,430 for a single taxpayer with no children to $57,414 for a married couple filing jointly with three or more children. To be eligible for the earned income tax credit, taxpayers are also limited to no more than $10,000 in investment income for the year. For those who qualify, it’s a refundable credit that could mean thousands of dollars in the pockets of low-income families.
Premium tax credit. Many people receive this credit throughout the year in the form of a health insurance premium subsidy. Created by the Affordable Care Act, it is offered to income-eligible households buying insurance coverage through the government’s health insurance marketplace. The credit is refundable, and the amount each household receives depends on their income and the price of health insurance in their area.
At tax time, people need to file a return and include the amount they received in subsidies. If someone’s income has gone up significantly in the previous year, they could end up having to pay back some or all of the credit.
Recovery rebate credit. The government sent out several rounds of stimulus checks — also known as economic impact payments — to help American households during the COVID-19 pandemic. Those who were eligible but didn’t get a payment can claim a recovery rebate credit on their 2021 tax return.
“This is for anyone who thinks they have missed a stimulus payment,” Strain says. However, only those missing the third stimulus payment of $1,400 per individual can claim the rebate on their 2021 return. If you’re missing the first or second stimulus payment — sent in 2020 — you’ll need to file or amend a 2020 tax return.
Eligibility for the third stimulus payment was limited to those with incomes of less than $160,000 for those who are married and filing jointly. The income limit for heads of household is $120,000, and it is $80,000 for other tax filing statuses.
Tax Credits for Investments
Foreign tax credit. The foreign tax credit allows taxpayers to receive a credit for foreign taxes they pay on income that is also subject to U.S. income tax. Even middle-class families may be eligible to receive this credit if they have invested in foreign mutual funds. Dividends from those funds may be subject to foreign tax, and U.S. taxpayers shouldn’t overlook the chance to receive a credit for those payments. If you have paid any foreign tax, it should be listed on the 1099 tax form you receive from your brokerage.
Retirement savings contribution credit. Also known as the saver’s credit, this credit is available to independent taxpayers who are 18 or older but not full-time students. It provides a tax credit of 10%, 20% or 50% of contributions to an IRA, employer-sponsored retirement plan or ABLE account. “They can get a credit of up to $1,000 for making these contributions,” Schwartz says.
To receive the maximum credit, married couples filing jointly can’t have an adjusted gross income of more than $39,500 in 2021. After that, the credit drops to 20% of contributions for couples earning $39,501 to $43,000 and 10% for those with incomes between $43,001 and $66,000.
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Update 01/13/22: This story was published at an earlier date and has been updated with new information.