What is a tax credit

0

A tax credit is a sum of money that taxpayers can subtract from the amount of tax they owe. They differ from deductions in that they do not reduce the amount of taxable income, but rather reduce the amount of tax they are required to pay.

There are many types of tax credit, and the value of each differs depending on the type of credit. Tax credits may be granted to individuals or businesses in certain locations, classifications or industries.

How Tax Credits Work

Tax credits can be granted by governments for a variety of reasons. This may involve inducing certain behaviors such as replacing older appliances or machinery with more energy efficient appliances or it may involve benefiting disadvantaged taxpayers by reducing the total cost of housing.

One of the biggest differences between tax credits and deductions is the amount by which it reduces the tax bill. For example, an individual in the 22% tax bracket would reduce their tax by $ 0.22 for every dollar they deduct. But they would save the whole dollar with a tax credit.

Types of tax credits

The three main types of tax credits are non-refundable, refundable and partially refundable.

Non-refundable tax credits

Non-refundable tax credits are directly subtracted from tax payable until tax due is $ 0. If there is an amount greater than the tax due, it is not refunded to the taxpayer. This is where the name non-refundable comes from. Any remaining amount of a non-refundable tax credit is effectively forfeited.

They are only valid for the reporting year and cannot be carried over to subsequent years. Typically, low-income taxpayers are often unable to use all of their tax credit. Types of non-refundable tax credits include adoption credits, lifelong learning credit, child and dependent credit, savers tax credit, and mortgage interest credit.

Refundable tax credits

The opposite of non-refundable tax credits is the refundable tax credit. As the name suggests, this type of tax credit pays a refund to the taxpayer if he does not claim the full amount of his tax credit. This means that taxpayers are entitled to their entire tax credit.

An example of a refundable tax credit is the earned income tax credit for low and moderate income taxpayers who earned income either through an employer or by working as a self-employed worker in a business. or a farm. They must also meet criteria established on the basis of income and family members. Other examples of refundable tax credits include the premium tax credit which helps cover the cost of health insurance premiums.

Partially refundable tax credits

These types of tax credits provide refunds to taxpayers who have not claimed the full amount of their credit, but only to the extent of fixed allowances. For example, since 2018, the Child Tax Credit has paid refunds of up to $ 1,400 per eligible child.

Another example of a partially refundable tax credit is the American Opportunity Tax Credit. Designed for post-secondary students, if the full $ 2,500 tax credit is not used, the taxpayer can claim the lesser of 40% of the remaining credit or $ 1,000.

For example, if a student used $ 2,000 of his tax credit to reduce his tax liability, he would be entitled to claim 40% or $ 200 of the remaining $ 500 in tax credits. But if they had used $ 0 of their tax credit, they could claim $ 1,000 in refund.


Source link

Share.

Leave A Reply