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Tax deductions are always useful, but tax credits are even more so. Deductions only reduce your taxable income, while credits are subtracted directly from your tax bill.
In the case of refundable tax credits, you may even be eligible for a refund beyond the amount of taxes that you pay. Non-refundable tax credits cannot be redeemed beyond the amount of tax you paid in – in other words, you can’t get a refund larger than the taxes that you owe.
Credits are taken in lines 48 to 54 of Form 1040, and lines 31 to 35 and 42 to 45 of Form 1040A. The instructions for these IRS forms covers eligibility for each of these credits, but we will go over some of the more popular ones in detail.
1. Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is probably the most popular credit. Aimed at low-income filers, it is fully refundable and is the only credit that can also be claimed on Form 1040EZ. Last year about $66.7 billion was paid out through EITC to 27.5 million tax filers.
To qualify, you must be a U.S. citizen or resident alien, must not file as married filing separately, and must have earned income and have a Social Security number (qualifying children need a Social Security number as well). Financially, your investment income must be below $3,400 for the 2015 tax year.
Credits range from $503 with no qualifying children to $6,242 with three or more; corresponding limits on adjusted gross income (AGI) are $14,880 and $47,955 respectively ($20,430 and $53,505 if married filing jointly).
2. Child Tax Credits
There are two levels of child tax credit: the regular non-refundable tax credit and the additional child tax credit (which allows the unused part of the child tax credit to be refundable if you qualify). The combined credits totaled over $55 billion in savings for taxpayers. Credits up to $1,000 per child are available.
To qualify, each child must be age 16 or less, a U.S. citizen, claimed on your tax return, live with you for at least half of the year, provide less than half of their own financial support, and meet relationship requirements (children, foster children, stepchildren/stepsiblings, or their descendants). Phase-outs based on income begin at $110,000 married, $55,000 married filing separately or $75,000 for singles.
There are two educational credits available: the American Opportunity Tax Credit (partially refundable) and the Lifetime Learning Credit (non-refundable). The AOC has credits up to $2,500 per student; the LLC offers up to $2,000 per return. Check the instructions for IRS Form 8863 to see the restrictions on income, available years, and educational requirements.
4. Retirement Savings Contribution Credits
This credit matches up to 50% of the contributions made to IRAs or 401(k)s, up to contribution limits of $2,000 for single filers and $4,000 for couples. Income limits are quite low for this one – $30,500 single, $61,000 joint – and the maximum credit is available at far lower incomes. Still, any credit that you qualify for is worth claiming, especially if you have a lower income.
Note: If you are part of a same-sex couple, you are eligible for these federal credits. While state tax laws are still unclear in the area of same-sex marriage, all of these tax credits apply to legally-married couples regardless of whether the state recognizes the marriage.
Other credits are available; look through the instructions of Form 1040/1040A for further details. Redeem all the tax credits that you can, and perhaps Uncle Sam will owe you instead of the other way around.