What Is a Tax Credit, Anyway? Potential Tax Burden Reduction

Tax credits can help reduce your tax burden and let you keep more of your money.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Tax credits: Reduce tax burden and keep more money in a refund
2 min read
Photo by Getty Images

Key Takeaways

  • Understand the difference between a tax credit and a tax deduction
  • Learn how the type of credit (refundable or nonrefundable) might impact your tax liability
  • Consider how recent changes in the tax code might affect your taxes  

Tax season is underway, which means figuring out what you owe—and finding ways to potentially reduce your tax burden.

You probably know that one way is through tax credits. But what are tax credits exactly, and how do they work?

Tax Credits vs. Deductions

First, let’s clear up any confusion between tax credits and tax deductions, because there’s an important difference. Tax deductions reduce the amount of taxable income. They depend on the taxpayer’s marginal tax rate, which rises with income, according to the Tax Policy Center. Also, any filer who takes the standard deduction isn’t allowed to take advantage of itemized deductions. But that’s not the case with tax credits.

At the most basic level, tax credits help decrease what you owe after all other deductions are considered. A tax credit reduces the amount of tax owed, dollar for dollar; your tax rate has no impact on a credit.

For individuals, tax credits fall into five general categories: family and dependents, income and savings, homeownership, health care, and education.

Nonrefundable Tax Credits

According to the Internal Revenue Service (IRS), there are two types of tax credits. The first is a nonrefundable tax credit, which means you get a refund only up to the amount you owe. These tax credits cannot reduce your tax liability below zero.

Here’s an example: If the tax credit is for $500, but you owe $300, you can only claim up to $300. (You don’t get $200 back.) Also, you can’t use nonrefundable tax credits to offset self-employment tax, nor taxes on withdrawals from Individual Retirement Accounts (IRAs) and other qualified retirement plans, according to the IRS. Most tax credits fall in this category.

Types of tax credits; refundable and nonrefundable

There are several nonrefundable tax credits available to filers. Here are some of the common:

  • Foreign tax credit
  • Child and dependent care credit
  • Education tax credit
  • Retirement savings credit
  • Child tax credit
  • Energy savings tax credit

According to the IRS, if you file for a tax credit, you often need to include separate or additional forms or schedules to prove you qualify.

Refundable Tax Credits

The second type is the refundable tax credit. With refundable credits, if the credit is greater than the amount you owe in taxes, you get a refund. So this time, if you owe $300 and the refundable tax credit is for $500, Uncle Sam will give you a refund for the remaining $200.

One refundable tax credit related to investing is a credit for tax on undistributed capital gains. Holders of mutual funds or real estate investment trusts who paid a tax on capital gains distributions may be eligible for a credit. Other well-known refundable tax credits include the earned income credit and the American opportunity tax credit for higher education.

Refundable tax credits are classified as payments, so unlike nonrefundable tax credits, the refundable credits can help offset your self-employment tax and qualified retirement plan distribution tax.

The tax reform that went into effect beginning with the 2018 tax year included changes to some tax credits and which taxpayers might be eligible. For example, the maximum child tax credit doubled from $1,000 to $2,000 per child, and the income phaseout threshold was raised, so more taxpayers will likely qualify than in previous years.

It’s worth working with your tax preparer to see which tax credits you may qualify for. Even if you weren’t eligible for tax credits in past years, the new tax code may have changed your eligibility status.

Qualifying for credits may not make preparing your taxes any more fun, but at least credits could help take the sting out of paying Uncle Sam.

TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.

Print

Key Takeaways

  • Understand the difference between a tax credit and a tax deduction
  • Learn how the type of credit (refundable or nonrefundable) might impact your tax liability
  • Consider how recent changes in the tax code might affect your taxes  
Call Us
800-454-9272

TD Ameritrade and all third parties mentioned are separate and unaffiliated companies, and are not responsible for each other’s policies or services.



Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2019 TD Ameritrade.

Scroll to Top