Understand Tax Credits and How They Work

We’re continuing our Tax Series with the best part of tax time, tax credits and tax deductions. Both reduce the taxes you owe, but they work in very different ways.
This week we’re focusing on the better of the two, tax credits. Why are they better? Because they reduce the taxes you owe, dollar for dollar, whereas a tax deduction reduces the income that you’re taxed on (more on this next week). For example, if you owe $2,000 in taxes a $500 credit reduces what you owe, dollar for dollar, down to $1,500.
A tax credit can be refundable or nonrefundable. A nonrefundable credit can only take you down to owing zero in taxes, it can’t lead to a refund. In other words if you don’t owe a lot in taxes, you won’t get the full value if the credit would take your tax bill below zero. It will just stop at zero. A refundable credit can result in a refund to you so you will get the full value of the credit even if it takes what you owe to below zero. The more well known credits are the Earned Income Tax Credit, Child Tax Credit and American Opportunity Tax Credit, which are all at least partially refundable. Some of the non-refundable credits include the Savers Credit, Senior Tax Credit and Residential Energy Credit, to name a few. Read our full article about tax credits here.
If you don’t qualify for any credits, you may still be able to reduce your taxes with deductions (stay tuned for next week’s article). You can also save money on taxes by utilizing any pre-tax accounts (401(k), HSA, FSA) that your employer may offer. Check your employer’s benefits for plans available to you or ask a BrightDime coach.