How Does a Tax Credit Affect My Taxes?

Saving money at tax time involves two basic approaches: making use of tax credits or using deductions. Credits are usually more advantageous because they come directly off your tax bill. A $1,000 tax credit is literally worth $1,000 to you. Deductions can only decrease the income you have to pay taxes on and your tax bracket affects them. If you're in a 28 percent tax bracket, a $1,000 deduction is worth $280 to you, because it reduces your income by $1,000. However, if you're in a 25 percent tax bracket, it's only worth $250.

How Credits Work

Credits are entered on the second page of your tax return if you file Form 1040. You subtract them after you determine your adjusted gross income on the first page -- all your sources of income minus your available deductions. Your adjusted gross income is what you must pay taxes on. If your adjusted gross income is $100,000, you're in a 25 percent tax bracket and you'd typically have a tax bill of $25,000. If you're eligible for $6,000 in tax credits, your tax bill drops to $19,000.

Eligibility

The IRS isn't particularly generous with its credits if yours is not a low-income family. For example, if you earned more than $45,060 in 2012, or $50,270 if you file jointly with your spouse, you're not eligible for the earned income tax credit. An available credit for retirement savings contributions, as well as some education credits if you're paying tuition for yourself or a dependent, also phase out at higher income levels.

Refundable vs. Non-Refundable

The effect that credits have on your taxes also depends on whether they're refundable or non-refundable, and on how much you owe the IRS. If you or your employer withheld adequate taxes from your earnings over the course of the tax year, you may owe the IRS a minimal amount or nothing at all. If a credit is refundable, it will erase your tax bill and the IRS will send you a check for any amount left over. For example, if you owe $500 and you're eligible for a $1,000 tax credit, the credit would erase the $500 and result in a refund of $500 to you. Most credits are not refundable, however. If you use a $1,000 non-refundable credit to erase your $500 tax bill, the IRS keeps the $500 balance.

Choices

Some tax credits overlap with certain tax deductions, and you generally can't claim both. For example, you can deduct tuition and related education costs if you're paying them for yourself or one or more dependents. But if you do this, you can’t also claim one of the education-related tax credits for paying tuition. You might want to calculate your taxes both ways to see which option benefits you most.

About the Author

Beverly Bird has been writing professionally since 1983. She is the author of several novels including the bestselling "Comes the Rain" and "With Every Breath." Bird also has extensive experience as a paralegal, primarily in the areas of divorce and family law, bankruptcy and estate law. She covers many legal topics in her articles.

Zacks Investment Research

is an A+ Rated BBB

Accredited Business.