A tax credit is usually more valuable than an equivalent tax deduction or tax allowance as the tax credit reduces tax directly, while a deduction or allowance only reduces taxable income. Therefore, the reduction in tax is only a fraction of the deduction or allowance, while a tax credit is real money.
As with deductions, tax credits can be reduced depending on your level of income. In some cases, the credit can be completely eliminated if you earn too much money. Your tax professional will be able to identify the credits in which you qualify for.
Common credits include the following:
- Earned Income Credit
- Child and Dependent Care Credit
- Credit for the Elderly or the Disabled
- Education Credits
- Retirement Savings Contributions Credit
For a list of all Tax Credits click here.
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Earned Income Credit
The Earned Income Credit (EIC), sometimes called the Earned Income Tax Credit (EITC), is a refundable federal income tax credit for low-income working individuals and families. Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. When the EITC exceeds the amount of taxes owed it results in a tax refund to those who claim and qualify for the credit.
The earned income tax credit can greatly benefit workers who don't make much money. This tax break returns, to qualified individuals, a portion of the taxes they have paid. It even can produce a tax refund for eligible filers who otherwise had no tax liability.
For 2006, the maximum a person could earn and still be eligible for the credit was $38,348 if married and filing jointly and had more than one qualifying child. If the person was single and had no qualifying children, the maximum you could earn in order to qualify for the credit dropped down to $12,120.
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Who Qualifies?
A common misconception is that the credit is available to parents only. That's not the case. However, the amount the IRS will give back is greater for eligible low-wage taxpayers with children.
To qualify for the EITC you must meet a specific set of conditions. First, you must work and earn income or you must be married to someone who works and earns income. Further, you must:
- Be a U.S. citizen or resident alien;
- Have a Social Security number;
- Have $2,800 or less in investment income.
And you cannot:
- File your tax return as married filing separately;
- Claim exclusion for income earned outside the U.S.;
- Have an adjusted gross income (AGI) greater than the earned income ceiling for your filing status and family situation.
If you claim children, you must attach Schedule EIC to their tax return.
- Children must have lived in the United States for more than half the year.
- Children must have lived with you within the United States for more than half the year.
- Children must be related to filer directly by marriage, adoption or foster.
- Children must be younger than 19 (or younger than 24 if they are full-time students).
- Disabled children, brothers, or sisters may also qualify.
And if you do not have children you must meet three additional tests before you can claim it:
- You must be at least 25 years old, but younger than 65;
- You cannot be the dependent of another taxpayer;
- You must live in the U.S. for more than half of the tax year.
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Child and Dependent Care Credit
If a parent or guardian paid someone to care for your child or dependent under the age of 13 or your disabled adult dependent or spouse so that you could work or look for work, you may be eligible to claim child or dependant care credits on your tax return. However, in each case, there are specific rules to be adhered to.
The expenses you paid must have been for the care of one or more of the following:
- Dependent was under the age of 13
- Spouse was mentally or physically not able to care for himself or herself and lived in your home more than one-half of year
- Dependant who was physically or mentally not able to care for himself or herself
In addition to the conditions above, in order to be eligible for the tax credit, you must also meet all of the following conditions:
- Provide the social security number of the qualifying person
- File your tax return jointly if married, unless the separation rules apply
- Hire someone other than your child (under age 19 at the end of the tax year), your spouse, or a person you can claim as a dependent
- Have qualifying expenses over and above any tax-free reimbursements from your employer
- Report on your tax return the name, address, and taxpayer identification number of the childcare provider. If the care provider is a tax exempt organization the taxpayer identification number is not required
The table provided below is an overview the credit type, maximum credit amount, and AGI limits. Having higher income levels may reduce or eliminate tax credit altogether.
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Credit Type
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Maximum Amount
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AGI Limits
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Child Tax
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Up to $1,050 per child
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Reduced above $75,000 if single, head of household, qualifying widow(er)
$110,000 if married filing jointly
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Child and Dependent
Care
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Up to 35% of expenses, to a maximum of $3,000 for one person, $6,000 for two or more
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All qualify but rate is gradually reduced to 20% of expenses for AGIs over $15,000
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Adoption
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Up to $10,630 per child
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Reduced above $159,450
Eliminated above $199,450 for single, head of household, and married filing jointly
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For more information regarding child and dependent care tax credits, see Publication 503, Child and Dependent Care Credits.
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Credit for the Elderly or the Disabled
This credit is available to individuals who are either age 65 or older, or are under age 65 and retired on permanent and total disability. Generally, you must be a United States citizen or resident to take the credit. You may also quality if you have reached your employer's mandatory retirement age.
The table provided below is an overview of the credit type, maximum credit amount and AGI limits:
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Tax Credit
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Maximum Credit
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AGI limits*
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Elderly or Disabled
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$750 single
$1,125 married filing jointly
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$17,500 single
$25,000 married filing jointly
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For more information regarding elderly or disabled credits, see Publication 524, Credit for the Elderly or the Disabled.
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Education Credits
You may qualify for tax credits for your higher education expenses. In most cases, higher education includes associates, bachelors and masters degree programs, as well as some doctoral programs. Higher education also includes vocational or technical certification programs at approved institutions.
There are two education tax credits available, the Hope Credit and the Lifetime Learning Credit. These credits are based on education expenses paid for you, your spouse or your dependents. You may be eligible to claim only one of the credits for each student during any school year. This credit amount is actually determined by the amount you pay for qualified tuition related expenses.
The expenses that qualify are tuition and fees required for enrollment or attendance at an accredited college, university, vocational school or other post secondary educational institution. Other qualified expenses may include fees for books, supplies, activity fees and equipment only if the fee paid for the student's attendance. Room and board, insurances, transportation or living or family expenses do not qualify.
Hope Credit
The Hope Credit is for eligible students who are enrolled at least half time in the first two years of education. An "eligible student" is defined as someone who:
- As of the beginning of the year has not completed the first two years of post-secondary education (that is, generally is a freshman or sophomore in college);
- Is enrolled in a program that leads to a degree, certificate or other recognized educational credential for at least one academic period during the year;
- Is taking at least one-half of the normal full-time workload for the student's course of study for at least one academic period beginning during the calendar year; and
- Is free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of the year.
You can claim a Hope Credit for only two tax years for each eligible student. An eligible student can be you, your spouse, or your dependent for whom you claim an exemption.
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Lifetime Learning Credit
The Lifetime Learning Credit is for all qualifying higher education expenses for eligible students. To be eligible for the credit, the student must be taking course work in order to acquire or improve job skills. There is no limit on the number of tax years for which the Lifetime Learning credit can be claimed for each student. The amount you can claim as a credit does not increase based on the number of students for whom you pay qualified expenses.
Both the Hope Credit and Lifetime Learning Credit may be reduced or even eliminated if your modified adjusted gross income exceeds certain limits based on your filing status. You cannot claim either credit if you are married filing a separate return.
The table provided below is an overview the credit type, maximum credit amount and AGI limits:
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Credit
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Maximum Credit
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AGI limits
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Hope
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$1,500 per student in each of two years (All of first $1,000 and half of second $1,000 paid)
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$55,000 if filing single
$110,000 if married filing jointly (in 2006)
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Lifetime Learning
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$2,000 per family per year
(20% of first $10,000 paid)
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$55,000 if filing single
$110,000 if married filing jointly (in
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For more information regarding education credits, see Publication 970, Tax Benefits for Education.
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Retirement Savings Contributions Credit
If you make eligible contributions to retirement savings plans you may actually be eligible for a tax credit. Such plans include traditional individual retirement arrangement (IRA), Roth IRA and even employer sponsored 401(K). This credit essentially offsets your contribution if your adjusted gross income (AGI) is less than the limits for your filing.
Some restrictions apply that limit eligibility of students or people who can be claimed as a dependant. However, if this does not apply to you, you can complete Form 8800.
For more information regarding retirement saving contributions, see Publication 590, Individual Retirement Arrangements (IRAs).