What a tax credit does

A tax credit is a dollar amount you subtract directly from the taxes you owe. If you owe $2,000 in federal income tax and you have a $1,500 tax credit, you owe $500. A credit is different from a deduction, which reduces your income before taxes are calculated — a credit cuts your final bill.

Tax credits come from the federal government and sometimes from your state. They exist because Congress wants to encourage certain behaviors or help certain groups of people. The child tax credit, for example, reduces taxes for people raising children. The earned income tax credit reduces taxes for working people with lower incomes.

Some credits are refundable, meaning if the credit is larger than what you owe, the government sends you the difference as a refund. Others are nonrefundable, meaning the credit can reduce your tax bill to zero but no further. A few credits are partially refundable — they work one way up to a limit and then refund the rest.

Key Takeaways

  • A tax credit subtracts directly from your tax bill, dollar for dollar, which makes it more valuable than a deduction of the same size.
  • Refundable credits can result in a refund if they exceed what you owe; nonrefundable credits can only reduce your bill to zero.
  • You claim credits on your tax return by filling out the correct form or schedule and attaching it to your return.
  • Income limits, filing status, and other conditions determine whether you can claim each credit, and these rules change from year to year.

Refundable versus nonrefundable credits

A refundable credit works like money in your pocket. If the credit is larger than your tax bill, you receive the overage as a refund check or direct deposit. The earned income tax credit (EITC) is refundable — a single parent earning $20,000 might owe zero in taxes but still receive a $3,000 refund because the EITC is worth more than their bill. The additional child tax credit is also refundable, up to a limit.

A nonrefundable credit can only reduce your tax bill to zero. If you owe $800 and have a $1,200 nonrefundable credit, the credit brings your bill to zero, but you do not receive the extra $400. The child and dependent care credit is nonrefundable. The lifetime learning credit is nonrefundable. Many education credits fall into this category.

A few credits are partially refundable. The American opportunity tax credit, for example, is nonrefundable up to the amount you owe, but 40 percent of any remaining credit (up to $1,000) is refundable. This means you might owe $1,500, have a $2,500 credit, and receive a $400 refund.

How to claim a credit on your tax return

You claim a tax credit by completing the correct IRS form or schedule and attaching it to your federal income tax return. The form depends on which credit you are claiming. The earned income tax credit uses Schedule EIC. The child tax credit uses Schedule 8812. Education credits use Form 8863. Each form asks for specific information — your income, the number of dependents, education expenses, or childcare costs — depending on the credit.

You fill out the form, calculate the credit amount according to the instructions, and then transfer that amount to the main tax return (Form 1040). If you use tax software, the software usually asks you questions about your situation and fills in the forms automatically. If you file by hand, you follow the line-by-line instructions on each form.

The IRS publishes a list of all available credits in Publication 17 (Your Federal Income Tax) and in individual publications for each credit. Your state tax return may have its own credits and its own forms. Some states use the same credits as the federal government; others have different ones.

Income limits and other conditions

Most tax credits have income limits. You can claim the credit only if your income falls below a certain threshold. The earned income tax credit has income limits that vary by filing status and number of children — a single person with one child might have a limit of $43,000, while a married couple filing jointly with three children might have a limit of $56,000. These limits change each year.

Credits also have other conditions. The child tax credit requires that the child be your dependent, be under age 17 at the end of the year, and have a valid Social Security number. The American opportunity tax credit requires that you (or your dependent) be enrolled at least half-time in a degree program at an accredited school. The child and dependent care credit requires that you paid someone to care for your child while you worked.

If you do not meet the conditions, you cannot claim the credit, even if you would benefit from it. The IRS does not waive conditions because your situation is close or because you almost meet the requirement. You either meet the condition or you do not.

Common credits and what they cover

The earned income tax credit (EITC) is for working people with lower to moderate income. It is refundable. The amount depends on your income, filing status, and number of children. A single person with no children might receive up to $600; a married couple with three children might receive up to $3,900.

The child tax credit is $2,000 per child under age 17. It is partially refundable — up to $1,700 per child can be refunded. You must claim the child as a dependent, and the child must have a valid Social Security number.

The American opportunity tax credit covers education expenses for the first four years of college or vocational school. It is up to $2,500 per student per year and is partially refundable (up to $1,000). The student must be enrolled at least half-time.

The child and dependent care credit covers childcare expenses while you work. It is nonrefundable and ranges from 20 to 35 percent of your expenses, depending on income. The maximum expenses you can claim are $3,000 per year for one child or $6,000 for two or more.

The lifetime learning credit covers education expenses beyond the first four years, including graduate school and professional certifications. It is nonrefundable and up to $2,000 per return per year.

How credits affect your refund or bill

Tax credits reduce the amount you owe or increase the amount you receive as a refund. If you owe $3,000 and have $2,000 in credits, you owe $1,000. If you owe $1,000 and have $2,000 in refundable credits, you receive a $1,000 refund. If you owe $1,000 and have $2,000 in nonrefundable credits, you owe zero and receive no refund.

The IRS applies nonrefundable credits first, then refundable credits. This means if you have both types, the nonrefundable ones reduce your bill first, and then the refundable ones reduce it further or create a refund.

You do not have to do anything special to receive a refund from a refundable credit. When you file your return and claim the credit, the IRS calculates whether you are owed a refund and sends it to you. You choose direct deposit or a check when you file.

Credits versus deductions

A deduction reduces the income that is taxed. A credit reduces the tax itself. A $1,000 deduction saves you money equal to your tax rate — if you are in the 22 percent tax bracket, a $1,000 deduction saves you $220. A $1,000 credit saves you $1,000, no matter your tax rate.

This makes credits more valuable than deductions of the same size. If you can claim either a $2,000 deduction or a $2,000 credit, the credit is always better. However, you cannot always choose — the tax code specifies which expenses may have access to for credits and which may have access to for deductions.

Some education expenses, for example, can be claimed as either a credit or a deduction, but not both. You have to choose which one saves you more money. The IRS worksheet in the instructions helps you compare.

Frequently Asked Questions

Can I claim more than one tax credit?

Yes. You can claim multiple credits on the same return if you meet the conditions for each one. A parent might claim the earned income tax credit, the child tax credit, and the child and dependent care credit all on the same return. Each credit has its own form, and you add them all together on your main return.

What happens if I claim a credit I am not may have access to to?

The IRS will disallow the credit and send you a notice. You will owe the tax you should have paid, plus interest. If the error was intentional, you may also owe a penalty. If the error was a mistake, the penalty is usually waived if you respond to the notice promptly and correct the return.

Do state tax credits work the same way as federal credits?

Most states have their own tax credits, and the rules vary by state. Some states follow federal rules closely; others have different income limits or conditions. You claim state credits on your state tax return using state forms. Check your state's tax agency website to learn which credits are available in your state.

Can I claim a credit if I do not owe any taxes?

If the credit is refundable, yes — you can receive a refund even if you owe zero. If the credit is nonrefundable, you cannot claim it if you have no tax bill, because there is nothing to reduce. Some people file a return even though they owe no tax, specifically to claim refundable credits like the earned income tax credit.

Do I have to file a tax return to claim a credit?

Yes. You must file a federal income tax return to claim any federal tax credit. If you are not required to file (because your income is below the filing threshold), you can still file to claim refundable credits. Many people with low income file specifically to claim the earned income tax credit and the child tax credit.