Many taxpayers use their tax refund as a sort of forced savings. That means that the taxpayer has had full use of their money for the entire year rather than giving the government an interest-free loan. I do understand the allure of a big refund check all at once, though.
Sometimes, taxpayer situations change and cause a large, if unexpected, refund. This happened to my family back in 2003 when my husband deployed a few months into the year, and we fell into the Earned Income Credit tax range due to his combat pay being nontaxable. We had two small children at that time and I was staying at home and working on my master’s degree, so we were able to take advantage of several credits that year.
I will be touching on the credits I see most often. Credits are usually more desirable than deductions when it comes to taxes. Credits are a dollar for dollar reduction in your tax bill, where deductions are a reduction in your taxable income. Depending on your tax bracket a dollar worth of tax credit can be worth up to three dollars of a deduction.
There are two types of tax credits: refundable and nonrefundable. Refundable credits can be returned to you, even if you have no tax liability. Nonrefundable credits can only be used to offset your tax liability.
Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is a refundable credit for those with low to moderate income who meet certain criteria. The income must be earned, either by working or owning a business that meets the criteria. For example, unemployment compensation does not qualify. There are special rules for military, clergy, those receiving disability benefits and affected by disasters. You must have a limited amount of investment income, be older than 24 but younger than 65 years of age. Taxpayers filing Married Filing Separately do not qualify for the EITC. Taxpayers must have qualifying children, or meet the tests for those without children. The maximum EITC for tax year 2017 is $6,318 with three or more qualifying children. Visit the IRS website for more information and an EITC Calculator to see if you qualify.
Child and Dependent Care Credit
This is a nonrefundable credit for the costs of care for a qualifying individual to allow you (and your spouse if you are married) to work or look for work. The dollar limit on the amount of the expenses you can use to figure the credit is $3,000 for the care of one qualifying individual or $6,000 for two or more qualifying individuals. The amount of your credit is between 20 and 35 percent of your allowable expenses. The percentage you use depends on the amount of your adjusted gross income.
Child Tax Credit
The child tax credit is a refundable credit, but it does phase out at higher income levels. In addition to meeting various criteria for a qualifying child, children claimed cannot be older than 17. The year the child turns 17 they will no longer qualify for the credit of up to $1,000 per qualifying child. If you claim the nonrefundable child tax credit but do not qualify for the full amount, you may also be able to take the refundable additional child tax credit. You must meet various criteria regarding the qualifying child. Tax year 2018 will bring changes to this credit; its value will go up to $1,400 and for other qualifying dependents, such children that have reached age 17, there will be a new $500 credit.
This nonrefundable credit is for low to moderate income individuals to encourage saving for retirement. In order to qualify, adjusted gross income must be less than $31,000 ($46,500 if head of household; $62,000 if married filing jointly) and you have made contributions to a 401(k), Thrift Savings Plan, other employer retirement plan or to a traditional or Roth IRA. The maximum credit is $1,000 each person, for a total of $2,000 married filing jointly. As with all credits, there are other specific rules that apply, so please take the time to read through the instructions for Form 8880.
Lifetime Learning Credit
Another nonrefundable credit, this credit for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses–including courses to acquire or improve job skills. Expenses for education must be paid out of pocket, so if the expenses are refunded or paid by scholarship, 529 plan or military tuition assistance or CAA, they do not qualify. There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return. To receive the credit your modified adjusted gross income (MAGI) must be $66,000 or less or $132,000 or less if you are married and filing jointly. There is an income phase-out, so you may be eligible for only a partial credit if your modified adjusted gross income exceeds $56,000 ($112,000 married filing jointly).
American Opportunity Tax Credit
Similar to the Lifetime Learning Credit, the American Opportunity Tax Credit is a credit for qualified education expenses paid out of pocket. The credit can help pay for the first four years of undergraduate education. The maximum annual credit is $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you. You cannot claim the credit if your MAGI is over $90,000 ($180,000 for joint filers). You may be able to claim a reduced credit if your income falls in the phase-out window.
There are other tax credits out there, but these are by far the most common. If you prepare your return yourself, you should definitely take the time to look up the details on each of these credits and see if you can reduce your tax bill or put a few more dollars in your pocket.
Have you ever been surprised by the outcome of your tax return – a big refund or a balance due?