Denice R. Preston
What is a tax credit?
Tax credits are different from tax deductions, which lower the amount of an individual’s taxable income. Tax deductions decrease an individual’s taxable earnings.
The amount of a credit is determined by its nature. Some tax credits are only available to certain types of businesses or individuals in specific locations, industries, or classifications.
Understanding Tax Credits
The federal and state governments can grant tax credits for specific behaviors that benefit the economy or the environment.
Tax credits are better than tax deductions because they reduce tax liability dollar-for-dollar. A deduction reduces the final liability only within the individual’s marginal tax rate.
For example, someone in the 22% tax bracket would save $0.22 per dollar of marginal tax deducted. A credit, however, would reduce tax liability by $1.
Nonrefundable Tax Credits
Tax credits that are not refundable amounts are directly deducted until the tax owed equals $0. The taxpayer is not entitled to a refund if the amount of tax due exceeds the part of the credit. The term “nonrefundable” means that the remainder of the nonrefundable tax credit, which cannot be used, is lost.
The nonrefundable tax credit can harm low-income taxpayers because they may be unable to utilize the total amount.
Tax Credits Refundable
The best credit is the Refundable Tax Credit because it’s paid in full. The taxpayer is entitled to receive the total amount of credit regardless of income or tax liability. If, for instance, the refundable credit reduces tax liability below $0, then the taxpayer will be entitled to a refund.
Earned income tax credit (EITC). Is one of the most popular refundable credits. The EITC provides a tax credit for low- and moderate-income individuals who work as self-employed or through their employer. They must also meet specific criteria based on the number of family members and income.
The tax credit for premiums is also refundable. The credit helps families and individuals pay for health insurance tips through the marketplace.
Tax Credits that are Refundable in Part
Some tax credits only partially refund. American Opportunity Tax Credit is one example.
If a taxpayer reduces their tax liability to zero before claiming the full $2,500 tax credit, the rest may be claimed as a credit refundable up to $1,000.
If a taxpayer owed a high enough amount in taxes, the Child Tax Credit would be $2,000. 15
The credit was increased to a full refund as part of the American Rescue Plan for the tax years 2020 and 2021.
Changes to the American Rescue Plan in 2021
The American Rescue Plan was passed by Congress in March 2021 and signed into law by President Biden. The plan allows eligible individuals to receive up to $1400 in stimulus checks.
The Child Tax Credit was also temporarily changed for married couples filing jointly and having an adjusted gross income (MAGI) of up to $150,000. For heads of households with MAGIs up to 112,500 or for single filers up to $75,000.
The amount of the credit is now fully refundable.
The bill removed the minimum income requirement. The bill eliminated the minimum income requirement.
EITC was also changed. The maximum Earned income tax credit for these same households had been $543. By 2022, it would be $560; by 2023, it would be $600. Before this, only people aged 65 and older could claim the credit. The upper limit has been eliminated, and the lower limit has been reduced to 19. (Anyone 19 years old or older who does not have a child, but meets the income requirements, can claim the EITC.) 23
There are a few exceptions. Students aged 19-24 with at least a half-time a full-time load of courses will not be eligible. Former foster youths or homeless youths can claim this credit at 18. The percentage of phaseout for single filers was increased to 15%, and the phaseout amount to $11,610.
These two EITC changes are permanent.
The investment income ceiling 2021 has been raised from $3.650 to $10,000. The $10,000 limit will be adjusted annually to reflect inflation.
The American Rescue Plan measures (including Child Care and Child/Dependent Care Credits) are temporary and only apply to 2021. For 2022 and later, they revert to their former forms.
Child and Dependent care credit
The Child Care Credit is not refundable for 2022. This credit is designed to help individuals and couples lower the cost of caring for children under 13. This credit is available to parents who need to arrange childcare so they can go to work or find employment.
The credit may be given if you care for an elderly spouse or dependent.
You can claim up to $6000 for each additional dependent. Credits range from 20% to 30% depending on your income. 30
For this credit to be available, you must have a filing status of single, married, filing jointly, or head of household.
Lifetime Learning Credit
The Lifetime Learning Credit can offset the cost of your postsecondary education, whether you have a degree or not.
For 2022, the full credit is available if your annual income is $80,000 or less for single filers or $160,000 or less for married couples filing jointly. For 2022, full credit is available if your annual income for single filers is less than $80,000 and for married couples filing jointly less than $160,000.
Retirement Savings Contribution Credit
The Retirement Savings Credit was designed to encourage low and moderate-income taxpayers to invest for retirement. The credit can offset a portion of the first $2,000 workers contribute towards their retirement accounts (IRAs), 401k plans, and specific workplace retirement programs.
This applies to contributions that are eligible for retirement plans. You must be 18 years old and not a full-time college student. You cannot be claimed on another person’s tax return as a dependent.
The maximum credit for 2022 is $1,000 for individuals or $2,000 for couples. Individuals can receive a maximum of $1,000 or pair up to $2,000.
