Tax Credits

A tax credit is not the same as a deduction.  In fact, they are far more valuable.  Unlike a tax deduction, most credits also have income phase out limits, which reduce the number of taxpayers that qualify.

Tax Deductions versus Tax Credits

A tax deduction is something that reduces a tax liability in a given year.  For example, it's possible to deduct mortgage interest payments on a federal income tax return.  When doing so, this deduction lowers an individual's Adjusted Gross Income, or AGI.  An individual in the 28% tax bracket that paid $10,000 in mortgage interest will pay $10,000 x 0.28, or $2,800 less in federal income taxes.

Tax credits, on the other hand, do not reduce the money owed by lowering taxable income.  Instead, credits act like additional income taxes withheld.  If someone paid $20,000 in federal income taxes, and is eligible for a credit of $1,000, then as far as the IRS is concerned, they paid $21,000 in taxes.  By effectively increasing federal taxes withheld, the individual will be eligible for a larger refund.

Federal Income Tax Credits

In general, there are four different programs the average taxpayer should be familiar with:

  • Child Tax Credits
  • Child and Dependent Care Credits
  • Earned Income Credits
  • Tax Credits involving Higher Education

Each of these programs is explained in the sections below, including the amount of credit that can be claimed on a federal income tax form, as well as qualifying rules.

Child Tax Credits

For the tax years 2015 and 2016, taxpayers may be able to claim a child tax credit of $1,000 for each qualifying child.  A qualifying child is one that was under the age of 17 at the end of the calendar year and is a child of the taxpayer, or that of a brother or sister, and is cared by the taxpayer as their own child; foster children are also eligible.  The qualifying rules state all these children must be a U.S. citizen or resident.

The child tax credit is phased-out if adjusted gross income is above a certain level. The phase out limits for this credit includes:

  • $110,000 for Married, Filing Jointly
  • $55,000 for Married, Filing Separately
  • $75,000 for Head of Household, Single, and Qualifying Widow(er)

Child and Dependent Care Credit

Anyone that cares for a dependent that is under the age of 13, or for other dependents that are not able to care for themselves, may be eligible for the child and dependent care credit.  This credit can be up to 35% of the expenses associated with the care of these individuals.  To qualify, a taxpayer (claimant) must satisfy all eight of the IRS tests summarized below:

  1. Expenses must be for a qualifying dependent, which was defined earlier (under age 13...).
  2. The claimant must pay at least half of the cost associated with owning and running the home the dependent lives in.
  3. The taxpayer and their spouse (if married), must both have earned income for the year.
  4. These expenses are paid so the taxpayer and their spouse (if married) can work or look for work.
  5. Care payments are made to someone that is not claimed as a dependent on the claimant's tax return.
  6. The tax filing status cannot be married filing jointly or qualifying widow(er) without a dependent.
  7. The care provider must be identified on the tax form.
  8. If the claimant excludes or deducts dependent care benefits provided by a care plan, the amount that can be deducted is limited to $3,000 if caring for one person or $6,000 if two or more persons were cared for.

More information on this topic can be found in IRS Publication 503, which provides a worksheet to calculate the exact credit.

Earned Income Credits

To claim the earned income tax credit, or EIC, an individual must have earned income, subject to limitations.  In 2015, a qualifying individual's adjusted gross income must be less than $18,110, or less than $23,630 if married and filing a joint return.  Income thresholds phase out for one qualifying child at $39,131, or $44,651 if married and filing a joint return.  If there are three or more qualifying children, the income level is raised to $47,747, or $53,267 if married and filing a joint return.

In 2016, a qualifying individual's adjusted gross income must be less than $18,190, or less than $23,740 if married and filing a joint return. Income thresholds phase out for one qualifying child at $39,296, or $44,846 if married and filing a joint return. If there are three or more qualifying children, the income level is raised to $47,955, or $53,505 if married and filing a joint return.

Individuals with more than $3,300 in investment income cannot claim this credit.  In 2015, the tax credits themselves range from $6,242 for taxpayers with three or more qualifying children, through $503 for taxpayers without a qualifying child.  In 2014, the tax credits themselves range from $6,143 for taxpayers with three or more qualifying children, through $496 for taxpayers without a qualifying child.  As was the situation with the Child and Dependent Care Credit, a worksheet is provided on the 1040 tax form to calculate the exact earned income credits.

Education Tax Credits

In 2015 and 2016, there are two tax credits that apply to higher education costs:  the Hope Credit, and the Lifetime Learning Credit.  The Hope Credit is worth up to $2,500 for each qualifying student, and is available during the first four years of postsecondary education.  The credit is phased out for taxpayers with adjusted gross incomes starting at $80,000 for single filers and $160,000 for joint filers.

The Lifetime Learning Credit is 20% of the first $10,000 paid for qualifying tuition and related expenses each year.  The maximum credit for 2015 and 2016 is $2,000.  Expenses for graduate and undergraduate work are eligible.  Unlike the Hope Credit, there is no limit on the number of years this credit can be claimed; however, it is subject to the same AGI income phase out rules.


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