Non-refundable tax credits can only reduce your tax liability to zero for the year. In the above example, $2,000 worth of non-refundable tax credits would reduce your liability to zero, but you also wouldn't receive the $1,000 refund.
Partially refundable tax credits, like the American Opportunity Tax Credit (AOTC), allow for a partial refund if the credit reduces your tax liability to zero. As of 2023, this amount is the lesser of 40% of the remaining credit or $1,000.
Overall, tax credits can be quite valuable, particularly to lower-income taxpayers with dependent children. Higher-income taxpayers benefit less from direct tax credits since they are frequently phased out from eligibility. Tax deductions tend to be more applicable for higher earners.
Why do tax credits matter?
Tax credits, particularly refundable ones, can make a huge financial difference for some families -- especially those with lower incomes and one or more dependent children. Certain tax credits, like the Child Tax Credit, Child and Dependent Care Credit, and Earned Income Tax Credit, provide relief to families facing the huge costs of child care and raising a family.
It's key to make sure that you're actually taking the tax credits you're entitled to. This is a discussion you'll need to have with your accountant or tax preparer around tax time, but if you think you might be eligible for certain credits, make sure to ask the questions in a timely fashion. Reviewing the available credits in advance can help you prepare.
As an example, a family earning $100,000 annually with three dependent children and a zero tax liability could be eligible for a refundable credit of $4,800 ($2,000 per child, of which $1,600 is refundable). Although the amount may not be earth-shattering, it is meaningful to a large percentage of American families. This is only one credit; The family might take be able to take advantage of other credits, too.
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