Tax credits overview

There is something good in the tax code

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Cheryl L. Dickerson, CPA

I can remember my introduction to accounting. It was called the language of business. As it turns out, accounting is the communication of the results and financial position of the business; but within the profession, there is a language that to a non-CPA may seem equivalent to gibberish. Modified adjusted gross income, net investment income tax, qualified business income, etc. On the surface, they seem like straight-forward terms. It may only be when your CPA starts to explain the intricacies that it all starts to sound like white noise.

You may have anticipated that the terms deduction and credit were just different ways to say the same thing. In the world of taxes, however, nothing could be farther from reality. Here’s a breakdown of the difference between the two, plus the tax credits available to you.

Credit vs deduction

A deduction, such as your home mortgage interest deduction, provides a tax benefit if you can itemize your deductions. The amount of your tax benefit is dependent on what we term your marginal tax rate. Under the current tax law, the tax rates range from 10 to 37%. For example, a $10,000 deductible home mortgage interest deduction would provide a tax benefit of $3,700 if you were in the highest marginal tax bracket and would reduce your tax liability by $3,700. A tax credit is a reduction of your tax liability on a dollar-for-dollar basis. If you had a $10,000 tax credit, your tax liability would be reduced by $10,000. Is there any wonder your CPA’s eyes light up when tax credits are part of your tax position?

There are a wide range of tax credits available to business entities and individuals. Many tax credit programs are designed to encourage specific behavior such as the increasing research activities credit, which was first implemented as an incentive to increase research and development activities. There are a myriad of credits that serve as tax incentives. The work opportunity credit, new markets tax credit, energy investment tax credit and the employer credit for paid family and medical leave created as part of the Tax Cuts and Jobs Act (TCJA) are just a few of the available credits.

The individual taxpayer was not forgotten in the realm of tax credits. Numerous credits exist that are directed to you. Here are several common tax credits that may impact your individual tax return.

Learn more: the impact of tax reform

Child tax credit

If you have qualifying dependents, you may be eligible for the child tax credit and credit for other dependents. The TCJA modified the previous child tax credit. Beginning in 2018, there is a $2,000 credit for each qualifying child under age 17. Up to $1,400 of the credit for each qualifying child can be refundable; so, in the event you owe zero tax, you may receive a refund.

If you have dependents who do not meet the child tax credit criteria, they may qualify for the $500 credit for other dependents. This credit is not refundable. Income levels for eligibility for the credit were expanded by the TCJA. Phase out of the credit now begins at $200,000 of modified AGI for single taxpayers and $400,000 for married filing joint. The previous levels were $75,000 for single and $110,000 for married couples filing a joint return.

Child and dependent care credit

Do you pay someone to care for your child, disabled spouse or other disabled dependent so you can work or look for work? If so, you may be eligible for a tax credit for child and dependent care expenses. To claim the credit, you must meet these requirements:

  • The qualifying child must be under age 13.
  • A disabled spouse or disabled person claimed as a dependent must be physically or mentally unable to care for themselves.
  • You must have earned income, however, there are allowances for full-time students or disabled individuals that may be applied.
  • The care provider can’t be your spouse, parent of your qualifying child or a person you can claim as a dependent.
  • If you’re married, you generally must file a joint return. If you are married filing separately and meet certain requirements, you may be treated as unmarried and be eligible for the credit.

Allowable expenses are limited to $3,000 for paid care of one qualifying person with a limit of $6,000 for care paid for two or more people. The credit varies between 20% and 35% of allowable expenses. The percentage is based on your income.

You must provide the care provider’s information including their Social Security number or employer identification number and address. If you received any dependent care benefits from your employer, you must complete Form 2441 to determine the amount of benefits that may be excluded from your income.

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Education credits

If you have a student attending college, you are already experiencing the financial impact of the cost of higher education. Education credits exist to help with the cost of higher education by reducing your tax liability. There are two education credits available:

  • American Opportunity Credit. This allows you to claim a credit up to $2,500 for adjusted qualified education expenses for the first four years of post-secondary education. Under certain circumstances, there is a portion of the credit that is refundable.
  • Lifetime Learning Credit. This is available for 20% of qualified education expenses up to your first $10,000 of qualified education expenses. This credit is nonrefundable.

To qualify for an education credit, you must meet these three criteria:

  1. You, your dependent or a third party pays qualified expenses for higher education.
  2. The eligible student must be enrolled at an eligible educational institution.
  3. The eligible student is either yourself, your spouse or a dependent listed on your tax return.

You may not take both credits for the same student in the same tax period and both credits are phased out as your income increases. There are additional qualifying requirements and coordination with benefits provided under a qualified tuition plan or Coverdell ESA. Be sure to ask your Henry+Horne tax professional about these credits if you have higher education expenses.

Foreign tax credit

You may have noticed a line on your investment statement that indicates foreign taxes paid. There is a tax credit for taxes paid to a foreign country or U.S. possession and the same income is also subject to tax in the U.S. The credit is intended to relieve you of a double tax burden when your foreign source income is taxed by both the U.S. and a foreign country. The foreign tax credit, as with other credits, can help reduce your U.S. tax liability.

Earned income credit

Working taxpayers who have low to moderate income may be eligible for the earned income credit, which reduces your tax liability and may result in a refund. You must meet strict requirements to qualify and you must file a return to claim the credit, even if you are below the filing requirements. The credit is based on a percentage of earned income (up to certain threshold amounts) which consists of wages, salaries, tips and earnings from self-employment. Certain levels of investment income, such as interest and dividends, may disqualify you.

Arizona credits

The State of Arizona has a number of credits available to taxpayers that allow you to direct your tax dollars to charity and reduce your state tax liability dollar for dollar. Reminder: there was a major change made concerning these credits thanks to the new tax law – any contributions qualifying for these credits that were made after August 27, 2018 are not eligible for the federal charitable contribution deduction.

  • Credit for contributions to a qualifying charitable organization. Maximum credit $400 single, $800 married filing joint.
  • Credit for contributions to a qualifying foster care organization. Maximum credit $400 single, $800 married filing joint.
  • Credit for contributions of fees paid to public schools. Maximum credit $200 single, $400 married filing joint.
  • Credit for contributions to a private school tuition organization (STO). Maximum credit $555 single, $1,100 married filing joint.
  • Plus switcher credit to a certified school tuition organization. Maximum credit $552 single, $1,103 married filing joint. This credit is only available if you have first donated to the STO credit. The combined switcher and STO credit is $1,107 single and $2,213 married filing joint.
  • Credit for contributions to the Military Family Relief Fund. Maximum credit $200 single, $400 married filing joint. This credit is only available for the first $1 million in donations and the fund regularly meets that well before the end of the year, so be sure to make your donation early.

You can designate your contribution for either the 2018 or 2019 tax year, if your contribution is made between January 1, 2019 and April 15, 2019.

Many credits available

The number of tax credits that exist are just far too numerous to go into detail and keep this article at a manageable length. The ability to reduce your tax liability on a dollar for dollar basis sounds like something that must just be too good to be true, but in this instance, it is true! Credits are valuable tax incentives and they’re very real.

As with every tax situation, talk to your Henry+Horne tax professional who can lead you to the best results for your situation and, of course, you’ll keep that glimmer in your CPA’s eyes.

Cheryl L. Dickerson, CPA, specializes in the preparation, review, planning and research for both individual and business tax returns. She can be reached at (480) 483-1170 or CherylD@hhcpa.com.