Tax time can feel like it’s all bad news but there are two bright spots. Tax credits and tax deductions are types of tax breaks that (generally) apply to those in need of additional assistance in certain situations (low income families, education assistance) or to encourage specific behaviors (charitable donations, solar energy credits.) The basic idea is to help offset expenses you paid throughout the year, reducing the amount of tax you but in very different ways.
Tax credits are considered “better” than tax deductions because they jump to the end of your tax return and directly reduce the amount of tax you owe, dollar for dollar.
Tax deductions, on the other hand, are applied in different places throughout your return and gradually reduce the amount of income that you’ll be taxed on at the end. Here is a quick example to show you the difference:
If you’re in the 25% tax bracket, a $1,000 deduction lowers your taxes by $250 (25% of $1000). And by comparison, a $1,000 credit lowers your taxes by the full $1,000.
Big difference! So, how do you take advantage of these credits? As with all tax topics, it’s a little complicated.
A tax credit can be nonrefundable or refundable. A nonrefundable credit means that if you don’t owe a lot in taxes, you won’t get the full value if the credit takes your total tax bill below zero. It will just stop at zero. For example: If your tax bill is $700 and you have a nonrefundable credit of $1,000, your tax bill will be zero. A refundable credit goes beyond your tax liability and can result in a refund.
In other words, a $700 tax bill combined with a $1,000 refundable credit will get you a $300 tax refund check.
And of course to further complicate things, there are also partially refundable tax credits where part of the credit is refundable and part of it is nonrefundable.
What are some of the credits available? Let’s start with the refundable credits. The Earned Income Tax Credit is available to low to moderate income earners and will depend on your filing status (single, married, etc). The Child Tax Credit is for parents with a dependent child (or children). It is available to a broad group since it is limited by a relatively high modified adjusted gross income (MAGI) The American Opportunity Tax Credit is a partially refundable tax credit available to students in their first four years of college that covers tuition, fees, books, etc. The Premium Credit is for those who purchase health insurance on the Health Insurance Marketplace.
Some of the nonrefundable credits available are: Child and Dependent Care Credit (designed to help offset the cost of childcare or taking care of an elderly parent), Adoption Credit (for adoption expenses), Premium Tax Credit (for those who purchased health insurance through the federal marketplace), Saver’s Credit (for those who contributed to a tax-advantaged retirement account), Senior Tax Credit (for low income elderly or disabled), Lifetime Learning Credit (for higher education expenses), Residential Energy Credits (for using solar powered systems), and Foreign Tax (for those who work or invest in foreign countries). For additional details, eligibility, and a complete list of all tax credits, read more here.
Your eligibility for tax credits depends on certain criteria specified by the IRS; often including your income, age, and tax filing status.
As we mentioned earlier, taxes can be complicated and with so many types of credits and deductions available, your best bet is to use an online or tax software program or a tax professional. They will guide you through a list of questions to determine which ones you are eligible for and ensure you maximize all that are available to you. If you don’t qualify for any, you can still save money by utilizing any pre-tax accounts (401(k), HSA, FSA) that your employer may offer. Still have questions? Ask a BrightDime coach!
This article was originally published in 2019. It was last updated in March of 2023.