TAX TIPS: Tax Credit, Tax Preparation Checklist
Tax credits are the hidden treasures of the tax world. They automatically reduce the amount of tax you owe, resulting in a dollar-for-dollar reduction in your tax liability. For instance, a $2,000 tax credit lowers your overall tax liability by $2,000, as opposed to tax deductions, which reduce the portion of your income that is taxed. Your taxable income is reduced by the deductions up to the maximum federal income tax bracket. As a result, if your tax rate is 22%, a $2,000 deduction will save you $440.
Distinguishing Between Credits and Deductions
The difference between tax credits and deductions is often misunderstood, but both serve the same purpose—saving you money on tax payments. Tax deductions lower a person’s tax liability by lowering their taxable income for the year, thus reducing the amount of tax you owe. Because there is less income to deduct and refunds give people with lower incomes more disposable income, tax credits are more valuable than deductions for them; in contrast, higher-income taxpayers prefer deductions because their income is subject to higher tax rates.
How Do Tax Credits Work in Practice?
You can determine how the credit will be allocated to your tax statement by looking at these categories:
● Nonrefundable
Tax credits that are nonrefundable lower your tax obligation by the equivalent credit amount. If you are eligible for a $700 nonrefundable credit, you can apply it to your tax bill to reduce the amount of taxes you owe by $700. The drawback is that this credit can only lessen or zero out your taxes owed; it won’t result in a refund if the credit amount is greater than your tax bill. As a result, it is most beneficial for taxpayers who anticipate owing money.
● Refundable
Refundable tax credits not only minimize your tax liability but filing one may also result in a refund. If your tax due is less than the credit amount when you file your tax return, you will be given a refund for the excess. If you owe $400 and are entitled to a $700 refundable credit, for instance, the IRS will return the extra $300 to you.
● Partially refundable
The final credit option is a balance between the first two. If your tax bill is less than the credit amount, you may be eligible for a partial refund for any overage, but only up to a specified amount. Partially refundable credits can reduce your tax charge by the corresponding credit amount. Suppose the credit is worth $1,000 but only $500 is refundable. In that case, you might either have your tax payment reduced by $1,000 or receive up to $500 back as a refund if the difference between your tax liability and the credit amount is less than $500.
Guide to Popular Tax Credits
Tax credits for people with kids are among the most well-known tax breaks:
● Child and Dependent Care Credit
Families can get help paying for childcare expenses spent while working or looking for work thanks to a federal tax benefit known as the Child and Dependent Care Credit. Families who must pay for the upkeep of an adult
dependent or a disabled spouse may also qualify for the credit.
● Child and Dependent Care Credit Eligibility
If you pay someone to look after one or more qualified persons so that you can work, seek work, or go to school full-time, and your income is under the credit’s upper and lower income limitations (and you’re married and filing a joint return), you might be entitled to claim the credit. The only exceptions to this rule are in cases when one spouse is a full-time student or is unable of providing for themselves because of physical or mental disease. You were fully responsible for the costs associated with keeping the home where you and your dependents live.
Your spouse, any person listed as a dependent on your tax return, and your children under the age of 19 are not eligible to receive care payments.
● The amount you’ll get
Depending on your adjusted gross income (AGI), the child and dependent care tax credit is a percentage of how much you spent on childcare related to your job during the year. If you have one qualifying dependent, you can deduct up to $3,000 in dependent care costs from your income; if you have two or more, you can deduct up to $6,000 in dependent care costs. The credit’s exact percentage depends on your adjusted gross income and can range from 20% to 35% of qualified expenses paid during the tax year. When AGI reaches $15,000, the credit proportion begins to fall. In general, the tax credit is larger the more you pay for dependent care while earning less.
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