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What Are Tax Credits and How Do They Help Save You More?

Organizing your finances and claiming tax credits can save you significant money.

If you are looking to start saving for retirement, or you are trying to make the most of your earnings, taking advantage of tax credits might be a valuable approach for you. But what is it, how does it work, and how can we all benefit from it?

What Are Tax Credits? 

A tax credit is an amount of tax that the taxpayer may subtract directly from taxes owed to the government. This means you can greatly reduce the amount of income going to the federal and state governments. They were designed to reward certain types of behavior that benefit the economy, the environment, or pay for the purposes that the government will deem important. 

Credits will cover expenses you paid during the year and have requirements that you must satisfy certain criteria before you can claim them. As a result, many people opt to work with experts in tax credit accounting instead of handling it themselves.

Understanding Tax Credits 

Government grants promote certain behaviors. For example, replacing old appliances. Tax credits are considered more favorable than tax deductions, as tax credits will reduce the tax liability dollar for dollar, ensuring you pocket the difference. 

The Types of Tax Credits

There are three different types of tax credits: 

Non-Refundable Tax Credits 

These items are directly deducted from the tax liability. Any amount greater than the tax you owe is not paid out. They are valid in the year of reporting only, so any from the 2020 tax year would not be carried over into 2021. Specific examples of non-refundable tax credits include the Lifetime Learning Credit, the Savers Tax Credit, and the Mortgage Interest Credit.

Refundable Tax Credits 

Refundable tax credits are the most beneficial because they are paid out in full. The taxpayer, regardless of their tax liability or income, will be entitled to the entire amount of credit. A very popular example is the Earned Income Tax Credit (EITC). 

Partially Refundable Tax Credits

Some tax credits are only partially refundable. As a result of the Tax Cuts and Jobs Act, the child tax credit became refundable as of 2018, with up to $1,400 per qualifying child. Another example is the American opportunity tax credit. 

How Can Tax Credits Help in My Life? 

Because tax credits are a great incentive in life, and even in education, you will see a lot more money in your pocket every year. Form 1040 is the IRS form used for personal federal taxes income returns to fill out. In order to qualify for one of the five biggest tax credits, Earned Income Tax Credit, American Opportunity Tax Credit, Lifetime Learning Credit, Child, and Dependent Care Credit, and Savers Tax Credit, you must have certain earning criteria. For example, to qualify for EITC, you cannot have earned $3,650 or more in 2020 from investment income.  

Tax credits can certainly help you in your life and can make a big difference to the money you take home. If you are looking to pocket a bit more money, it's worth addressing this, as having tax credits can make a big impact on your financial and tax situation. 

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