People often talk about getting tax deductions, but that’s actually not what a tax credit is. Here’s the main distinction between the two terms:
- A tax deduction lowers the amount of your income that is taxable. For example, you might have $50,000 in income, but deductions reduce the taxable portion to $35,000.
- A tax credit directly reduces your tax bill itself.
In other words, after all tax deductions have decreased your taxable income, imagine that you still owe $1,000 in taxes. But then you also have a tax credit of $1,000 from a preferred activity. That credit, then, would cancel out your tax bill. The government gives tax credits to reward certain beneficial activities, such as buying energy-efficient products or caring for children.
What Is a Tax Credit?
A way to imagine a tax credit is to think of a home utility bill. If you reduce your energy usage each month, that will reduce your bill, and that is analogous to a tax deduction. But imagine if you were to receive your energy bill and saw these lines:
- $100 charged for monthly utilities
- $100 credit added to account
- $0 balance
That would mean that somehow a credit was added to your bill, and you now owe nothing. That is similar to how a tax credit works. It effectively adds payment to your final tax bill, although if a tax credit would more than pay off your bill, it often does not turn into a tax refund payment.
It’s very important to know what tax credits you might qualify for in order to pay only the tax amount you truly owe. These tax credits may be refundable, nonrefundable, or partially refundable. What these terms mean is:
- Refundable: This type of credit can give you a tax refund payment if it would reduce your taxes to zero and then to a negative number. For example, if you owed $500 in taxes and took a $1,000 refundable tax credit, you could get a $500 refund.
- Nonrefundable: Most tax credits simply reduce your tax bill without offering a refund. If the example in the previous bullet was nonrefundable, it would simply reduce the tax bill to zero.
- Partially Refundable: A certain percentage of this type of credit is available as a tax credit. In the example above, if the $1,000 credit were partially refundable at 30%, then only $300 of it would be reportable as a refundable credit, so you would get $300. $700 would be nonrefundable, reducing your $500 tax bill to zero; then, $300 would be reportable as a refundable credit.
Tax credits are incentives to get taxpayers to perform certain actions, such as buying products that are good for the environment, adopting a child, paying for an education, or taking care of children.
How Much Is a Child Tax Credit?
You can receive a tax credit to your tax bill of $2,000 for each qualifying dependent child. That means they are younger than 17 years old during the tax year, are US citizens, and have Social Security numbers before the tax due date (of course, you also must have a Social Security number).
These dependents can be your biological children, adopted, stepchildren, or foster children. To receive the tax credit, you must claim the child as a dependent and have that child living with you for at least half of each year. Finally, you have to earn less than a certain income threshold, such as $200,000 per year.
A Child Tax Credit is partially refundable. You may be able to get a tax refund of up to $1,400 if the tax credit reduces your tax bill to zero.
Hire TaxHelp MD to Maximize Your Tax Credits
There are tax credits associated with many positive activities, including raising children and earning an education. But you must file your taxes correctly by filling out the right forms, in order to receive these credits.
Be sure to get the funds that the government makes available. Contact Tax Help MD for help understanding tax credits, deductions, paying off tax bills, and more. Schedule an appointment now with Tax Help MD.