Various tax benefits allow you to reduce the overall amount of your tax liability. Understanding the difference between these benefits is key to maximizing your return.
While Tax Deductions are subtracted from your taxable income — reducing its amount and thus lowering the tax you eventually need to pay — using Tax Credits is often considered more beneficial. This is especially true if the credits are “refundable.”
The Two Main Types of Tax Credits
Tax credits generally come in two types: refundable and nonrefundable. It is important to note that most credits are not refundable.
Nonrefundable Tax Credits
A nonrefundable tax credit allows you to write off any amount of tax you owe to the IRS directly. However, if the credit amount exceeds your total tax liability, you will not receive the excess amount back as a refund. Your tax bill simply becomes zero.
Refundable Tax Credits
As for refundable tax credits, they offer a significant advantage. If your tax liability is less than the credit amount, the IRS will send you the remaining portion as a tax refund check.
Common List of Tax Credits
Here are some of the most common federal tax credits available to taxpayers:
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The Earned Income Tax Credit (EITC): This is a valuable refundable credit designed to reimburse taxpayers with low to moderate income.
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The Child and Dependent Care Credit: This credit actually reimburses the taxpayer for part of the amount they must pay to a caregiver for watching their children (under 13 years old) or dependents with disabilities while they work.
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The Child Tax Credit: If your earnings are not higher than the amount established by the IRS, you have the right to claim a credit for each of your qualifying children under 16 years old (as of the last day of the tax year).
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The Adoption Credit: This reimburses you for qualified expenses related to adoption. It is not refundable, but you can carry forward any unused portion of the credit for up to 5 years, using it to pay taxes in the future.
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The Credit for the Elderly or Disabled: Provided to taxpayers aged 65 and older and those with permanent disabilities. To receive it, income must not exceed the amounts established by the IRS.
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The Saver’s Credit: Also known as the “retirement savings contributions credit,” this is a kind of reward for contributions you make to an IRA or employer-sponsored retirement plan. The percentage you are entitled to claim depends on your income level.
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The Premium Tax Credit: Designed to cover the cost of your health insurance premiums. It can only be issued to those who have health insurance purchased through the Health Insurance Marketplace.
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American Opportunity Tax Credit (AOTC): Designed for qualified education expenses you pay for yourself, your spouse, or your dependents for the first four years of higher education. Its amount depends on education expenses, and only taxpayers whose income levels don’t exceed certain limits can receive this credit.
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The Lifetime Learning Credit (LLC): This is another education credit with more flexible qualification rules for students. It can be used to pay for undergraduate, graduate, and professional courses, including courses taken to improve job skills.
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The Recovery Rebate Credit: A credit you can receive as government assistance related to Economic Impact Payments during the COVID-19 pandemic.
What’s the Difference Between Tax Credits and Tax Deductions?
The primary difference is that unlike tax credits, tax deductions only reduce the amount of your income that is subject to tax.
| Feature | Tax Credits | Tax Deductions |
| Impact on Taxes | Directly reduces the amount of tax you owe to the IRS dollar-for-dollar. | Reduces the amount of your taxable income, lowering the percentage you are taxed. |
| Impact on AGI | Does not affect your Adjusted Gross Income (AGI) or eligibility for other credits. | Can reduce your AGI, potentially allowing you to claim other income-based tax benefits. |
| Refunds | The amount of some types of credits (refundable) exceeding what’s needed to pay taxes can be refunded to you. | Not refundable; they can only reduce your taxable income to zero. |
Income Requirements for Tax Credits (AGI vs. MAGI)
Most requirements for receiving tax credits regarding maximum income limits relate to your Adjusted Gross Income (AGI), not the total (gross) amount of income you earned for the year.
Your AGI is the amount that remains after you make certain adjustments to your total income to reduce it, but before you subtract the Standard Deduction or Itemized Deductions. You can find this on line 11 of Form 1040.
Some tax credits instead use your Modified Adjusted Gross Income (MAGI) to determine eligibility. Although for most taxpayers, MAGI is the same as AGI, certain deductions and income sources may need to be added back in to calculate MAGI.
We recommend you consult with a tax professional if you are unsure which tax credits you are entitled to claim based on your income and situation.
How Can Gennadiy Arnautov CPA Help?
Tax credits are powerful tools for directly reducing your tax liability dollar-for-dollar, but navigating the eligibility rules, income thresholds (AGI vs. MAGI), and documentation requirements can be complex. Our specialists will help:
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Identify all refundable and nonrefundable tax credits you are eligible for in your specific situation.
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Accurately calculate your income to ensure you meet the requirements for credits like the EITC or Child Tax Credit.
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Develop a strategy to maximize both credits and deductions for the lowest possible tax bill.
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Ensure compliance with IRS regulations to avoid errors or delays in your refund.
Don’t leave money on the table — especially refundable credits! The right guidance can mean a significantly larger refund or a lower tax bill.
Contact Gennadiy Arnautov CPA for professional consultation and to maximize your tax savings.
