When it comes to minimizing your tax liability, tax credits play a crucial role. Unlike deductions that reduce your taxable income, tax credits directly reduce the amount of tax you owe. This article explores various tax credits that can help you save money on your taxes.
Child tax credit
The child tax credit is a tax credit that is available to taxpayers who have qualifying children. The amount of the child tax credit depends on the number of qualifying children you have. The maximum credit per child for 2023 is $2,000.
To qualify for the child tax credit, the child must meet certain criteria, including age, relationship to the taxpayer, residency, and support. Additionally, there are income limitations that may reduce or eliminate the credit for higher-income taxpayers.
Education tax credits
Education tax credits are tax credits that are available to taxpayers who pay for qualified education expenses. There are two education tax credits:
- American Opportunity Tax Credit (AOTC): The AOTC can help offset the cost of college tuition, fees, and other expenses. It is available for the first four years of post-secondary education, and the maximum credit is $2,500 per year per student. To qualify for the AOTC, the student must be pursuing a degree or other qualifying education credential.
- Lifetime Learning Credit: The Lifetime Learning Credit can be claimed for qualified education expenses paid for by the taxpayer, their spouse, or their dependents. The credit is worth 20% of the first $10,000 of qualified education expenses, for a maximum credit of $2,000 per tax return regardless of how many students included on the tax return are claiming the credit. Unlike the AOTC, there is no limit on the number of years the Lifetime Learning Credit can be claimed, and it can be used for undergraduate and graduate courses, as well as qualifying courses to acquire or improve job skills.
To claim these education tax credits, the taxpayer must meet certain eligibility requirements, including income limitations and enrollment in eligible educational institutions.
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Earned Income Tax Credit
The Earned Income Tax Credit (EITC) is a refundable tax credit for low- and moderate-income working individuals and families. The credit can be used to offset your tax liability or even result in a refund. The amount of the EITC you can claim depends on your income, filing status, and the number of qualifying children you have.
To qualify for the EITC, you must meet certain criteria, including earned income and adjusted gross income (AGI) limitations. The EITC is particularly beneficial for families with children.
Childcare and Dependent Tax Credit
The Childcare and Dependent Tax Credit is a tax credit for qualifying expenses paid to care for dependents under the age of 13, disabled dependents of any age, or a disabled spouse. The credit can be claimed by taxpayers who work, are looking for work, or who are full-time students. The amount of the credit you can claim depends on your income, filing status, and the amount of qualifying expenses you paid.
To qualify for the Childcare Tax Credit, you must meet certain requirements, including the use of qualified child care providers and the provision of necessary information related to the care provider.
Foreign Tax Credit
The Foreign Tax Credit is a tax credit for taxes paid to foreign governments. The credit can be used to offset your U.S. tax liability. The amount of the credit you can claim depends on the amount of foreign taxes you paid and the type of income on which the taxes were paid.
Generally, foreign taxes on wages, dividends, interest and royalties qualify for the credit. File Form 1116 to claim the Foreign Tax Credit on your tax return.
Saver's Tax Credit
The Saver's Tax Credit is a tax credit for contributions made to qualified retirement savings plans, such as traditional IRAs and 401(k) plans. The credit is available to taxpayers with incomes below certain limits that make qualifying retirement plan contributions. The amount of the credit you can claim depends on your income, filing status, and the amount of your contributions.
To qualify for the Saver's Tax Credit, you must meet certain eligibility requirements, including age, income limitations, and the type of retirement plan contributions you made.
Other tax credits
In addition to the credits mentioned above, Matt Chancey, a certified financial planner with Coastal Investment Advisors, says there are several other tax credits that taxpayers may be eligible for, depending on their circumstances. Some examples include:
- Solar credits: These credits can help offset the cost of installing solar panels on your home or business.
- Low-Income Housing Tax Credit (LIHTC): This credit helps finance the development of affordable housing.
- Film and movie credits: These credits can be used to offset the costs of producing films and television shows in the U.S.
Chancey also recommends these deductions for those who may qualify:
- Deductions for oil and gas: These deductions can help offset the costs of exploring and producing oil and gas.
- Deductions for animal breeding: These deductions can help offset the costs of raising livestock.
- Bonus depreciation and expensing for real estate professionals: These provisions allow real estate professionals to deduct the cost of certain assets in the year they are placed in service.
- Deductions for equipment leasing: These deductions can help offset the costs of leasing equipment.
“The government creates programs that allow investors to make their own choices about how they invest in new technologies or industries that should expand the economy,” Chancey said. “The general theme is based on economic expansion and the government provides a path to substantial tax benefits for investors that financially qualify to make such investments.”
Other ways to minimize taxes
Financial advisers say taxpayers might consider these tactics to minimize their tax liability:
Qualified Charitable Distribution: Taxpayers who are 70½ or older and charitably inclined may consider making a qualified charitable distribution (QCD) from their IRA, said Clarke. A QCD is a direct transfer of funds from the taxpayers IRA to a qualified charity. The amount of the QCD is excluded from their taxable income, which can save them money on your taxes.
There are, however, limits to how much a taxpayer can QCD each year. For 2023, the maximum QCD is $100,000. If a taxpayer is married filing jointly, they and their spouse can each QCD up to $100,000 for a total of $200,000.
Michelle Gessner, a certified financial planner with Gessner Wealth Strategies, said many taxpayers who are at or over the age of 70½ are unaware that they can use the QCD strategy to donate money to their favorite qualified charity and still take the standard deduction so that they get the benefit of a reduction in their taxable income from the donation without itemizing. “Without the QCD strategy, seniors who take the standard deduction get no tax benefit from their charitable donations,” she noted.
Donor-advised fund: Taxpayers with appreciated investments may consider funding a donor-advised fund (DAF) with those investments, said Brian Clarke, a certified financial planner with Clarke Financial Counsel.
A DAF is a charitable giving account that allows donors to make tax-deductible contributions of appreciated assets, such as stocks, bonds, and real estate. The donor then has the flexibility to recommend grants from the DAF to charitable organizations over time.
There are benefits to funding a DAF with appreciated investments. One, the donor can deduct the fair market value of the assets donated. And, two, the donor doesn’t have to pay capital gains taxes on the appreciated assets.
Know your Adjusted Gross Income: Many of the credits are tied to your adjusted gross income, or AGI, according to Stephen Maggard, a certified financial planner with Abacus Planning Group. “This means that if your income is above a certain threshold, you may not be eligible for the credit despite qualifying in every other way. You may check all the other boxes to qualify for the credit, but if you make too much, then you do not qualify.
Take, for example, the American Opportunity Tax Credit. “In 2023, if you are a married couple filing jointly and make over $180,000, you are not allowed to take the credit,” Maggard said. “In fact, you start losing the full benefit of the credit once you break the $160,000 AGI mark.”
There are also adjustments to income that reduce AGI, said Sallie Mullins Thompson, a principal with a firm bearing her name. That list, which can be found in Form 1040 Schedule 1, Part II, includes such items as contributions to health savings accounts or HSAs; the deductible part of self-employment taxes; IRA contributions; healthcare insurance premiums paid by the self-employed; contributions to self-employed retirement plans; student loan interest; educator expenses; penalties paid for savings early withdrawals; and alimony paid (pre-2019 divorce agreements).
Check your state and local laws: States also have their own tax credits and deductions, so taxpayers also want to look at their local tax rules, said Maggard.
Many states, for instance, provide a tax break for retirees. For example, in South Carolina retirees can deduct 100% of their Social Security income, 100% of any military retiree income, and a separate deduction for those over age 65.
Consider a 529 plan: Qualified tuition programs, also called 529 plans, are used by many families to prepay or save for a child's college education. “These plans provide either tax deductions or credits, depending on the plan,” said Ed Snyder, a certified financial planner with Oak Tree Advisors.
He noted that the CollegeChoice 529 for Indiana, the state in which he resides, provides a 20% Indiana tax credit (must be an Indiana resident) for contributions up to a maximum credit of $1,500 per year.
Editor's Note: The content was reviewed for tax accuracy by a TurboTax CPA expert for the 2022 tax year.
Robert Powell is editor and publisher of Retirement Daily on TheStreet.
