In the context of taxes in the United States, a tax credit refers to an amount of money that can be directly subtracted from the taxes a person owes to the government. It is a way to reduce the total amount of taxes owed, and in some cases, it can even result in a refund if the credit exceeds the amount of taxes due.
There are two main types of tax credits in the United States: refundable credits and non-refundable credits.
Refundable Credits
Refundable credits are those that, if the amount of the credit exceeds the amount of taxes you owe, the government will return the difference to you in cash. Some examples include:
Earned Income Tax Credit (EITC): This credit helps workers with low to moderate incomes. If the amount of the credit is greater than the taxes you owe, the IRS refunds the difference.
Child Tax Credit (CTC): For 2024, the Child Tax Credit continues to be partially refundable if not all of the taxes owed are used. The refundable portion is called the "Additional Child Tax Credit".
American Opportunity Credit (AOC): This credit, related to educational expenses, also has a refundable portion. 40% of this credit can be refunded if there are not enough taxes to cover it.
Premium Tax Credit (PTC): For people who buy insurance through health marketplaces, the Premium Tax Credit is refundable, depending on their income and household size.
Non-Refundable Credits
Non-refundable credits can only reduce the amount of taxes you owe to the IRS. If the credit exceeds the amount of taxes you owe, you will not receive the difference. Some examples include:
Credit for Child and Dependent Care Expenses: Helps those who pay for childcare or dependent care while working, but is not refundable.
Lifetime Learning Credit (LLC): This credit, related to educational expenses, is not refundable.
Foreign Tax Credit (FTC): Credits that apply to taxes paid to foreign governments. It is useful if you work abroad, but it is also non-refundable.
Saver's Credit: This credit helps people with low to moderate incomes save for retirement, but it is not refundable.
In summary, how are tax credits applied?
Direct tax reduction: A tax credit directly reduces the total amount of taxes you owe. If you owe $3,000 in taxes and have a $1,000 credit, you will only pay $2,000.
Refundable: If you have a refundable credit and owe less tax than the credit covers, the IRS will return the difference to you.
Non-refundable: If you have a non-refundable credit but do not owe enough tax, you will not receive a refund.
Conclusion
Tax credits are very valuable because they can significantly reduce your tax liability, unlike tax deductions, which only reduce the amount of income subject to tax. It is important to note that credits can only be applied if you meet certain requirements set by the IRS, and the amounts of credits may vary depending on your personal situation, such as your income, dependents, or expenses in specific areas like education or childcare.
For more specific details about the credits for the 2024 tax year and their implications for your tax filing in 2025, we suggest consulting the latest IRS publications, such as Publication 17 (Your Federal Income Tax). You can also schedule an appointment at Professional Taxes, and we will gladly provide you with the most up-to-date information based on your specific situation.
Comments