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.
People shouldn’t feel embarrassed if they don’t understand tax credits.
“This is an area of confusion,” says Eric Bronnenkant, head of tax for online financial advisory firm Betterment. “Before I was involved in taxes, I was confused about it.”
Credits are an efficient way to reduce a tax bill, but they can have complex rules. For instance, they may only be available to those with certain incomes or apply only to taxpayers who have made specific purchases during the year.
Keep reading to learn more about how tax credits differ from deductions and which federal tax credits apply to your situation.
[Read: How to File a Tax Extension.]
What Is a Tax Credit?
Tax credits shouldn’t be confused with tax deductions.
“A tax credit is a dollar-for-dollar reduction in one’s tax liability,” says Logan Allec, CPA and owner of tax relief company Choice Tax Relief. “A tax deduction reduces your taxable income.”
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, for instance, a $1,000 deduction will save $220 in taxes.
“In general, a tax credit is more valuable than a tax deduction,” Allec says.
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 has their own eligibility criteria.
Find Tax Credits for Your Situation
As tax laws change, so too do tax credits. What’s more, major life milestones — such as the birth of a child or enrolling in college — may make a person eligible for new credits.
“We issue tax organizers to all of our clients,” says Guy Finocchiario, a CPA in Melville, New York. This document asks people about their sources of income, any changes from the previous year and other life events. “It gives us a complete picture of what their situation is,” he explains.
If you complete your own tax return, many tax software programs will walk users through a questionnaire that asks similar questions to determine what tax forms — and credits — may apply.
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.
— Energy efficient home improvement/clean energy credits.
— Foreign tax credit.
— Retirement savings contribution credit.
Keep reading to learn more about these credits and who can claim them.
[READ: How to Pay Less on Retirement Account Withdrawals.]
Tax Credits for College
American opportunity credit. Those paying college tuition have two tax credit options. The more 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.
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. The income ranges at which the credit phases out are between $80,000 and $90,000 for single filers, and $160,000 to $180,000 for joint filers. 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. “This is probably one of the common (credits),” Bronnenkant says. It offers a tax credit to income-eligible families with children ages 16 and under. The credit is worth $2,000, of which $1,400 may be refundable to qualifying parents.
“Of course, this tax credit was a lot bigger in 2021,” Allec says. During that year, credits could be as much as $3,600 per child, and the government made monthly advance payments to qualifying parents. The provision of law that provided for the larger credit and advance payments has expired, so the credit amount has reverted back to its previous level.
To receive a child tax credit, parents must provide more than half of the support for the child being claimed. 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.
Child and dependent care tax credit. The child and dependent care tax credit is available to those who pay for child care so they can work. “That’s the key,” Allec says. “You need earned income.”
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.
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, once a taxpayer’s adjusted gross income reaches $15,000, the credit percentage declines until it reaches 20% for those earning $43,000 or more a year.
Adoption credit. This credit can help reimburse parents for legal fees and other costs associated with adoption. The maximum credit is $14,890 per child. While the credit is not refundable, any unused portion can be carried forward for up to five years.
You’ll need a modified adjusted gross income of $223,410 or less in 2022 to receive the complete credit. Above that, the tax benefits are reduced and then eliminated if your income hits $263,410.
[READ: Tax Prep Checklist: Collect These Forms Before Filing Your Taxes.]
Tax Credits for Income-Eligible Households
Earned income tax credit. The earned income tax credit can be lucrative for those who qualify. “It could be several thousand dollars,” Finocchiario says. “That’s why it’s highly audited.”
The maximum credit for 2022 is $6,935 for a household with three or more qualifying children. However, for those with no qualifying children, the maximum credit is only $560.
“The credit is very much geared toward those with dependents,” Allec says. Taxpayers without children also must have very low incomes to qualify.
Income limits range from $16,480 for a single taxpayer with no children to $59,187 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 $10,300 in investment income for the year.
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, it could result in a significant tax bill.
“If people lied (about their income) when they filled out their applications, they are going to have to pay back all those credits,” Logan says.
Tax Credits for Investments
Energy efficient home improvement/clean energy tax credits. Thanks to the recently passed Inflation Reduction Act of 2022, those investing in their homes with energy-efficient upgrades can take advantage of enhanced tax credits.
The energy efficient home improvement credit was extended to apply to qualified property installed through the end of 2022. The credit is equal to 10% of the cost of certain expenses, such as insulation and exterior windows and doors. A combined tax credit of $500 is available for all years after 2005.
There is also a residential clean energy credit for those making clean energy improvements to their home, such as installing qualified solar electric, geothermal heat and biomass fuel equipment. The credit is equal to 30% of the cost of property put into service in 2022 through 2032.
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.
“American citizens living abroad and working can get a foreign tax credit for (foreign taxes) paid on their income,” Finocchiario says.
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.
“Actually, quite a few people claim that one,” Bronnenkant says. 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.
To receive the maximum credit, married couples filing jointly can’t have an adjusted gross income of more than $41,000 in 2022. After that, the credit drops to 20% of contributions for couples earning $41,001 to $44,000 and 10% for those with incomes between $44,001 and $68,000.
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Update 01/10/23: This story was published at an earlier date and has been updated with new information.
