What is a Tax Credit and Who Does and Does Not Qualify for Them

By James R. Leichter

How is a Tax Credit Different from a Tax Deduction?

A tax credit and a tax deduction both reduce your tax liability, but they do so in different ways:

  1. Tax Credit:
    • A tax credit directly reduces the amount of tax you owe, dollar for dollar.
    • For example, if you owe $5,000 in taxes and you have a $1,000 tax credit, your tax liability is reduced to $4,000.
    • Tax credits can be either refundable or non-refundable. Refundable credits can result in a refund if they reduce your tax liability below zero, while non-refundable credits only reduce your tax liability to zero.
  2. Tax Deduction:
    • A tax deduction reduces your taxable income, which in turn lowers the amount of tax you owe based on your tax bracket.
    • For example, if you are in the 22% tax bracket and you have a $1,000 deduction, your taxable income is reduced by $1,000, which results in a tax saving of $220.
    • Deductions are generally subtracted from your gross income to arrive at your adjusted gross income (AGI) and then your taxable income.

When is Someone Not Eligible for a Tax Credit?

Eligibility for tax credits can vary based on the specific credit and individual circumstances. Common reasons someone might not be eligible for a tax credit include:

  1. Income Limitations:
    • Some tax credits have income caps and are phased out or eliminated if your income exceeds certain thresholds. For example, the Earned Income Tax Credit (EITC) has specific income limits based on filing status and number of dependents.
  2. Lack of Qualified Expenses:
    • Certain credits require specific expenses to be incurred, such as educational expenses for the American Opportunity Credit. If you do not have these qualified expenses, you cannot claim the credit.
  3. Tax Filing Status:
    • Certain credits are restricted based on your filing status. For example, the Child and Dependent Care Credit may have different rules for married couples filing separately.
  4. Residency or Citizenship Requirements:
    • Some credits require you to be a U.S. citizen or resident alien for the entire tax year. Non-resident aliens may be ineligible for certain credits.
  5. Age or Dependent Status:
    • Some credits have age requirements or are only available to taxpayers with qualifying dependents. For example, the Child Tax Credit is available only for qualifying children under a certain age.
  6. Alternative Minimum Tax (AMT):
    • Certain credits may not be available if you are subject to the AMT, which can limit or eliminate the benefit of some tax credits.

Final Points

Understanding the specific eligibility criteria for each tax credit is crucial to ensure you can claim it appropriately. If you have specific credits in mind, it’s advisable to review the IRS guidelines or consult with a tax professional to determine your eligibility.

Your Comments and Suggestions are Welcome

I hope this helps you better understand Tax Credits, Tax Deductions, and how they differ.

Please leave your comments or questions and I will try to answer them.

Thank you!

James R. Leichter (about me)
RA Tax and Accounting, Inc.