What are Tax Credits?
Tax credits are amounts that taxpayers can subtract directly from the taxes they owe to the government. Unlike deductions, which only reduce the amount of income that is subject to taxation, tax credits provide a dollar-for-dollar reduction in tax liability.
Types of Tax Credits
- Nonrefundable Credits: These can reduce your tax liability to zero, but not below zero. If the credit value exceeds your tax liability, you lose the remaining amount.
- Refundable Credits: These can reduce your tax liability to below zero. If the credit exceeds your tax bill, the government will pay you the difference.
Common Tax Credits
Some common examples include:
- Earned Income Tax Credit (EITC): Designed to benefit low- to moderate-income working individuals and families.
- Child Tax Credit: Available to taxpayers with dependent children under the age of 17.
- Education Credits: Such as the American Opportunity Credit and the Lifetime Learning Credit, aimed at helping with higher education expenses.
Understanding the Impact
Tax credits can significantly lower your tax bills, thereby freeing up more money for investments and personal finance goals. They are an essential aspect of financial literacy and personal finance management.