Your 2021 Guide to Tax Credits

There are two main ways Americans can save money on their taxes -- tax deductions and tax credits. And here's the big difference: Tax deductions reduce the amount of income that is subject to federal income tax, while tax credits reduce the amount of tax you owe, dollar for dollar.

For that reason, tax credits can be far more valuable, but some of the most common tax credits available in the United States are not well understood by many taxpayers. So here's a look at some of the most common tax credits you should know, and how much they could save you on your 2021 federal income tax return.

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Tax credits you should know

There are a bunch of tax credits in the United States tax code, but some are more commonly used than others. Here's a list of some of the most popular tax credits, followed by what you should know about each one of them:

• Child Tax Credit
• Credit for other dependents
• Child and Dependent Care Credit
• Earned Income Tax Credit (EITC)
• The Retirement Contribution Savings Credit (Saver's Credit)
• American Opportunity Tax Credit (AOTC)
• Lifetime Learning Credit (LLC)

Here's what you need to know about each one of these tax credits for 2021:

Child Tax Credit

The Child Tax Credit is available to taxpayers who have children who are under age 17 at the end of the year. So, in 2021 this means that any children who turn 17 before January 1, 2021 are not eligible.

For 2021, the Child Tax Credit is worth $2,000 per qualifying child, and households can claim the Child Tax Credit for every child who qualifies. For example, if you have three children 16 or under, you can take a Child Tax Credit of $6,000.

The Child Tax Credit is a partially refundable tax credit. This means that even if the taxpayer has no tax liability, as much as $1,400 of the Child Tax Credit can still be given in 2021.

The Child Tax Credit is income-restricted, meaning that it isn't available to taxpayers whose adjusted gross income exceeds certain levels. Here's a quick guide to the thresholds for each tax filing status to help you determine whether you might qualify for the credit in 2020.

Data source: IRS. These thresholds are not adjusted each year for inflation.

Here's an example of how phase-out thresholds work. Let's say you file a joint tax return in 2021 and that you have qualifying children. If your AGI is $100,000 in 2021, you're well below the phase-out threshold, and you'd be entitled to the full $6,000 credit for your three children. If your AGI is $415,000, you're in the middle of the two thresholds, and you would therefore be entitled to a credit, but less than $6,000. Lastly, if your AGI is $500,000 for the year, you'd earn too much to claim the Child Tax Credit at all for the 2021 tax year.

Credit for other dependents

The Child Tax Credit is a big help to many parents, but what if your child is 17 or older? What if you have a college-aged child whom you support financially, or if you have an aging parent you take care of? That's where the Credit for Other Dependents comes in.

This tax credit was created as part of the Tax Cuts and Jobs Act and is a nonrefundable credit that is worth as much as $500 for each dependent. While this isn't nearly as much as the Child Tax Credit, it does provide some much-needed tax relief for Americans with dependents who previously didn't qualify for any credits at all.

Child and Dependent Care Credit

To help provide some relief to offset the cost of child care for working parents, there is the Child and Dependent Care Credit.

Now, not everyone who pays for care can use the credit. There are some criteria that need to be met in order to use the credit:

• The taxpayer must have earned income. In other words, the credit is only available to working adults. (Caveat: If you're disabled or a student, this requirement doesn't apply.)
• The child is under age 13 or disabled
• You don't use Married Filing Separately status.

The child care expenses don't necessarily need to be paid to a business, so you can pay someone to come to your home to watch your children. However, there are some rules, particularly about relatives -- for example, you can't pay your college student to watch their younger siblings and claim the Child and Dependent Care Credit for those expenses.

The Child and Dependent Care Credit is worth 20%-35% of as much as $3,000 in qualifying expenses for one child, or $6,000 for two or more children. But everyone qualifies for some credit -- the lowest percentage is 20%, regardless of income.

Furthermore, if you have a dependent care flexible spending account (FSA) through your employer, you can't use the money you set aside in that account and the Child and Dependent Care Credit toward the same expenses. But with the high cost of child care in the United States, many parents (unfortunately) have enough expenses to use both.

Earned Income Tax Credit (EITC)

The Earned Income Tax Credit, or EITC, is a fully refundable tax credit and is designed to help lower-income working families. This is a potentially valuable tax credit -- the EITC can be worth thousands of dollars for certain taxpayers.

The EITC is only available to taxpayers who have earned income – which means income from a job or self-employment activities.

For 2021, here's a quick guide to the maximum AGI to claim the EITC, as well as the maximum credit amounts for various numbers of dependents:

Data source: Tax Foundation.

Retirement Contribution Savings Credit (Saver's Credit)

The Saver's Credit is designed to encourage Americans to save money for retirement.

If your AGI is lower than the IRS's threshold for your tax filing status, the Saver's Credit is worth 10%, 20%, or 50% of your qualified contributions. Qualified retirement contributions include as much as $2,000 per person to tax-advantaged retirement plans -- this includes IRAs, 401(k)s, 403(b)s, and just about every other variation.

For 2021, here are the Saver's Credit income limitations for different tax filing statuses:

Data source: IRS.

For example, let's say that you file a joint return with your spouse for the 2021 tax year and you have AGI of $60,000. You can deduct 10% of your first $2,000 in retirement contributions, and so can your spouse. So, if you each contribute $2,000 into a retirement plan, you qualify for a tax credit of $400.

American Opportunity Tax Credit (AOTC)

There are two education tax credits and the American Opportunity Tax Credit (AOTC) is the tougher one to qualify for but is also more lucrative.

To qualify for the AOTC, the student must be pursuing a degree, certificate, or other credential. They also must be enrolled on at least a half-time basis and completing one of their first four years of post-secondary education, among other requirements.

The AOTC also has income restrictions. The person claiming the credit must have modified adjusted gross income (MAGI) under $160,000 (joint) or $80,000 (any other status), in order to receive the full credit. If the taxpayer has MAGI of more than $180,000 (joint) or $90,000 (all others), they can't claim the credit at all.

However, this can be a very valuable tax credit to those who qualify. It is worth 100% of the first $2,000 of qualified higher education expenses and 25% of the next $2,000 of qualified higher education expenses, for a maximum credit of $2,500 per student, per year, and the credit is partially refundable.

Lifetime Learning Credit (LLC)

The Lifetime Learning Credit is not nearly as restrictive as the AOTC. It is commonly used by taxpayers who paid tuition for someone who is beyond their fourth year of post-secondary education or not enrolled in an official academic program.

The LLC can be taken for almost any higher education expenses. If you take a single course at your nearby community college for no particular reason, it could qualify.

However, the LLC is designed for taxpayers with low to moderate incomes. Taxpayers must have adjusted gross income of $119,000 or less (joint filers) or $59,500 or less (all others) in 2021 to claim their full LLC. The credit phases out entirely for AGI over $139,000 or $69,500, respectively. See the discussion on the Child Tax Credit earlier if you're curious how phase-out thresholds work.

The Lifetime Learning Credit is worth 20% of as much as $10,000 in qualified higher education expenses, for a maximum of $2,000 total (not per student) per year.

Not an exhaustive list of tax credits

To be clear, this is not an exhaustive list of every tax deduction available in the United States. In addition to the common tax credits discussed here, there are many others that might apply to you, such as:

• The Federal Adoption Tax Credit, worth as much as $14,440 per child adopted in 2021.
• The Foreign Tax Credit, if you paid any taxes to a foreign government.
• The Residential Energy Efficient Property Credit
• The Plug-In Electric-Drive Motor Vehicle Credit

Could these 2021 tax credits change?

With the election of Joe Biden to the White House, there's a good possibility that there will be some significant changes to the tax code under his administration, and these changes could certainly affect some of these tax credits we've discussed here. As one example, Biden has suggested changing the EITC rules. And while Biden's term doesn't start until about three weeks into 2021, it's entirely possible that any tax changes could be made retroactive to Jan. 1.

Having said that, the most likely scenario is that any changes (if they happen at all), wouldn't take effect until 2022, Biden's first full year in office. After all, the Tax Cuts and Jobs Act was passed toward the end of 2017 but didn't go into effect until the 2018 tax year, President Trump's first full year in the White House.

So, while there is a possibility that some of these tax credits could change for the 2021 tax year, and it's certainly worth keeping an eye on it, the figures discussed here are likely to remain in effect.