Smart use of tax credits can make a huge difference for people struggling to pay for childcare, education or retirement.

Tax credits are often more valuable than tax deductions because they reduce the amount of tax you owe on a dollar-for-dollar basis. For example, if you have a $1,000 tax credit, your tax bill will be reduced by $1,000. But suppose you have a $1,000 tax deduction. In that case, your tax bill is reduced by the amount of the deduction multiplied by your tax bracket – so if you're in the 22% tax bracket, the $1,000 deduction would reduce your bill by $220. Quite a difference!

There are two types of tax credits: non-refundable and refundable. Non-refundable tax credits reduce your tax liability to zero, but you won't receive a refund if the credit exceeds the amount of tax you owe. For example, suppose you owe $500 in taxes and have a $1,000 non-refundable tax credit. In that case, your tax liability will be reduced to zero, but you won't receive the extra $500 as a refund.

On the other hand, refundable tax credits can reduce your tax liability to zero, and you may receive the remaining credit amount as a refund. For example, suppose you owe $500 in taxes and have a $1,000 refundable tax credit. In that case, your tax liability will be reduced to zero, and you'll receive the extra $500 as a refund.

Some common tax credits include:

American Opportunity Tax Credit (AOTC)

The AOTC is a credit for higher education expenses that can provide a credit of up to $2,500 per eligible student per year for the first four years of college. To qualify for the AOTC, you must have paid qualified education expenses for yourself, your spouse, or your dependents. However, the credit begins to phase out for higher-income taxpayers, starting at $80,000 of modified adjusted gross income for single filers and $160,000 for joint filers.

The Child and Dependent Care Tax Credit (CDCTC)

The CDCTC is a tax credit designed to help working parents or guardians pay for the care of a child under 13 or a qualifying dependent while they work or look for work. The credit can be applied to expenses related to daycare, summer camp, before and after-school care, and similar services. 

The 35% credit applies to up to $4,000 of expenses for one child or dependent and up to $8,000 for two or more dependents. However, the percentage of allowable expenses decreases for higher-income earners, reducing credit value. Additionally, payments made through tax-advantaged programs such as a dependent-care flexible spending account at work may lower the amount of the credit.

Child Tax Credit (CTC)

The CTC is a tax credit available to eligible taxpayers with a qualifying child. You could receive up to $2,000 per qualifying child, and in some cases, you could even receive a refund of up to $1,500 - even if you don't owe taxes. 

To be eligible for the credit, the child must be under the age of 17, claimed as a dependent on your tax return, be related to you, live with you for at least half of the year, and be a U.S. citizen, U.S. national, or U.S. resident alien. You must also provide at least half of their financial support. The CTC is phased out for taxpayers with higher incomes.

Earned Income Tax Credit (EITC)

You may be eligible for the EITC if you are a low-to-moderate-income taxpayer. The credit is based on your earned income and the number of qualifying children in your household. The maximum benefit is up to $7,430 in 2023 for families with three or more children. 

The EITC is refundable, which means that if the credit exceeds the tax owed, you will receive a refund for the excess amount. To be eligible for the EITC, you must have earned income during the tax year and meet specific income requirements, which vary depending on your filing status and the number of qualifying children you have.

Electric Vehicle Tax Credit (EVTC)

The EVTC is a credit of up to $7,500 on purchasing new electric vehicles. However, significant limitations include the maximum vehicle cost, your income, and the location of the vehicle's final assembly.
Lifetime Learning Credit (LLC)

The LLC is another credit for higher education expenses that provides a credit of up to $2,000 per tax return. Unlike the AOTC, the LLC has no limit on how many years it can be claimed and can be used for graduate-level courses or job-skills training. Like the American Opportunity Tax Credit, the credit begins to phase out for higher-income taxpayers, starting at $80,000 of modified adjusted gross income for single filers and $160,000 for joint filers.

Residential Energy Credits

Taxpayers who make energy-efficient home improvements, such as adding insulation, energy-efficient windows, or installing solar panels, may be eligible for a residential energy credit. The credit is worth up to 30% of the cost of qualifying improvements.

Retirement Savings Contributions Credit (Saver's Credit)

The Saver's Credit is a credit for taxpayers contributing to a qualified retirement account, such as an IRA or 401(k). The credit is worth up to $1,000 for individuals and $2,000 for couples filing jointly, based on the amount contributed and income. Eligibility is limited to couples earning less than $79,000 and single filers earning less than $38,500.

The Takeaway

Whether it's reducing educational expenses, supporting child and dependent care, encouraging sustainable energy use, or saving for retirement, each credit offers a unique avenue to improve your tax situation and, by extension, your financial health.