Here’s a quick rundown of how tax credits function and an outline of the most common ones you could be eligible for.

What is a tax credit?

A tax credit is a dollar-for-dollar decrease in a taxpayer’s tax burden. This is distinct from a tax deduction. A tax deduction is the amount the IRS permits taxpayers to deduct from their adjusted gross income (AGI) in order to reduce their taxable income.

Tax credits are available at both the federal and state levels. This is to encourage particular behaviors (for example, acquiring an electric car) or to cover the cost of certain costs (e.g., raising or adopting a child).

How are tax credits calculated?

Taxes are typically calculated based on your income and the tax laws in your jurisdiction. The process of calculating taxes generally involves the following steps:

Determine your taxable income: Your taxable income is the portion of your income that is subject to taxes. This is typically calculated by subtracting any deductions or exemptions from your gross income.

Calculate your tax liability: Once you have determined your taxable income, you can calculate your tax liability using brackets and rates for your jurisdiction. Tax rates are typically progressive, meaning that the higher your income, the higher the tax rate.

Deduct any credits and offsets: You can then deduct tax credits or offsets that you qualify for, such as earned income tax credit or child tax credit. These credits are subtracted from the tax liability, reducing the amount of taxes owed.

Calculate any additional taxes or penalties: Depending on your jurisdiction, there may be additional taxes or penalties that you need to pay. These include self-employment tax or penalty for underpayment of estimated taxes.

Pay taxes: After calculating your liability, you must pay taxes to the government by the due date each year.

Tax credits are classified as nonrefundable, refundable, or partially refundable. These categories indicate how the credit will be allocated to your tax statement. The vast majority of tax breaks are not refundable. A good tax software program will show you any credits you may be eligible for and how to claim them.

Quick guide to tax credits 

Tax credits are a great way to lower your tax bill and increase your refund. Some of the most common tax credits include:

It is important to note that tax laws and calculation methods can vary depending on the country and jurisdiction. The qualifications and maximum credit amount for each credit may also change from year to year. So it’s a good idea to check the tax laws and regulations in your area or speak with a tax professional to confirm your eligibility and the amount you can claim.

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