There are many strategies to lower your tax liability and one of the best ways to achieve that is a tax credit or a tax deduction. Credits and deductions are triggered by life events and demand you to meet certain conditions. Some credits required you to study, others to save towards retirement, making it almost impossible to claim all of them, but adequate planning and preparation can get you closer to qualify for them.
What is a tax credit?
A tax credit is an amount you can subtract directly from your tax liability. For example, after including all income and navigating through a tax return you arrive at a tax liability of $5,000, a $2,000 tax credit would bring your liability down to $3,000
What’s the difference between a tax credit and a tax deduction?
Those two terms are sometimes used interchangeably but there is a significant difference between the two. A tax deduction lowers your taxable income, which typically has a lower impact on your overall liability than a tax credit. For example, if you qualify for a $3,000 deduction, your $50,000 annual salary would be considered $47,000 for tax purposes. To see the exact impact on your savings, multiply your marginal tax bracket (based on your income and filing status) by the amount of deduction.
What are some credits that can significantly lower your tax liability?
Here is a sample of tax credits that can save you some money this tax season. Not everyone will qualify for them but they are absolutely worth exploring:
- The child tax credit – maximum credit amount of $1,000 per dependent child; you may qualify if you have a qualifying child of 17 years old or younger but there are adjusted gross income limits to who can claim it; limit amount is based on the filing status.
- .The child and dependent care credit – this credit is based on the expenses related to caring expenses you paid (while working) for qualifying children of 13 years old or younger, or for a disabled spouse or a dependent.
- The earned income tax credit – maximum credit amount of $5,891 for low income individuals; the amount and eligibility is based on earnings, number of eligible children, and filing status.
- The retirement savings contributions credit (Saver’s credit) is designed to help workers save up additional funds for retirement; there is a maximum earnings limit in order to qualify and it is required that a worker contributes to an IRA or some other retirement plan at work.
- The American opportunity tax credit – maximum credit amount of $2,500 for post-secondary school students covering education expenses; Form 8863 is a worksheet that helps to determine the correct credit amount.
- Lifetime learning tax credit – maximum credit amount of $2,000 and it uses the same Form 8863 to calculate the precise amount; there are different rules that apply to this credit vs The American opportunity tax credit and only one can be taken at once.
- Adoption Credit – maximum credit amount of $12,650 for adopting a child 18 years old or younger offsetting any qualified adoption expenses; there are income limits to qualify for this credit (typically affecting higher income households) and Form 8839 is a worksheet that considers individual’s and employer-provided adoption benefits.