One of the most common questions we receive from clients is, “How can I reduce my income tax liability?” It’s no wonder – after all, no one wants to pay more taxes than they have to. Below, we’re discussing how taking full advantage of tax credits can help you retain more of your hard-earned dollars. Plus, discover the types of tax credits that could apply to you.
Before we continue, it’s important to note the differences between a tax deduction and a tax credit:
Tax deductions reduce your taxable income, so that when you calculate your tax liability, you’re doing so against a lower amount. Typically, deductions will increase or decrease in size depending on your tax bracket. For example, if you are in the 12% tax bracket and qualify for $10,000 in tax deductions, your taxable income is reduced by 12% of $10,000, or $1,200.
A tax credit, on the other hand, is a dollar amount applied to your total tax obligation and is constant across all tax brackets. That means that a tax credit of $400 will reduce your total tax liability by $400, regardless of the tax bracket you are in.
Are you making the most of your business’ tax credits or deductions? Our team of hard-working accounting professionals can help you minimize your taxable income or tax liability with our acute knowledge of federal tax codes. Give Pine & Co. a call to schedule a meeting today.
Individual Tax Credits
Now that we’ve defined the lingo, let’s talk about the possible federal tax credits you could qualify for:
When it comes to individual income tax credits, let’s just say, well, there’s a lot. To sort through these, the IRS breaks them down into several basic groups, but one of the most important distinctions is whether they are a nonrefundable credit or a refundable credit.
- Nonrefundable tax credits apply to personal expenses and allow you to receive a refund only up to the amount you owe. If there is an excess credit, your tax liability stays at zero, but you don’t receive a cash refund from the IRS. (Note that the adoption credit, the residential energy efficient property credit, and the home mortgage interest credit have slightly different rules and may be carried forward to a later tax year(s) for additional tax benefits).
- Refundable credits are those that allow you to receive a refund past the amount that you owe. Examples include the credits for withheld taxes (§31 and §33), the earned income credit (§32), the gasoline and special fuels credit (§34), the health insurance costs credit (§35), and the credit for coverage under a qualified health plan (§36B).
The IRS then separates tax credits for individuals based on the purpose behind on the credit. These include:
Family and Dependent Credits: These types of credits are designed to provide relief to low-income taxpayers and to families with children. Examples include the household and dependent care credit (§21), the credit for the elderly and disabled (§22), the adoption credit (§23), and the child tax credit (§23).
Income and Savings Credits: This classification of credits offers relief to those earning low or moderate-levels of income who may or may not have children, and certain individuals who save for retirement. Examples include the Earned Income Credit (EIC) (§32) and the elective deferrals and IRA contributions credit (§25B).
Homeowner Credits: These credits provide relief for certain low-income taxpayers who own a home or those taxpayers who update or maintain an energy-efficient home. Examples include the home mortgage interest credit (§25), and the residential energy efficiency property credit (§25D).
Health Care Credits: These credits help taxpayers who faced certain expenses due to health insurance costs. Examples include the health insurance costs credit (§35) and the qualified health plan coverage credit (§36B).
Education Credits: Education credits offer relief to those taxpayers with expenses related to higher education, and include the American Opportunity and Lifetime Learning credits (§25A).
Business Tax Credits
Of course, tax credits aren’t just limited to an individual’s tax liability. Business tax credits can also help small businesses reduce their tax liability based on certain activities or provisions.
Small business owners may be familiar with the general business credit (§38). It is unique in that it’s not a single, separate credit. Instead, it encompasses a variety of specific tax credits that promote certain business activities, such as research, employer-provided childcare, new pension plans, or even reforestation. All these individual credits are added up separately on individual forms, with each credit amount calculated under differing rules specific to each. The final combined credit of all of them is carried over to the General Business Tax Credit Form 3800 to determine the total allowable credit.
The general business credit consists of numerous credits designed to encourage certain business activities. The most commonly applied credits include:
- the investment tax credit (§46)
- the work opportunity credit (§51)
- the low-income housing credit (§42)
- the disabled access credit (§44)
- the new energy-efficient home credit (§45L, through 2017)
- the employer-provided childcare credit for employers that provide childcare assistance to employees (§45F)
- the small employer pension plan startup cost credit (§45E)
- the employer social security credit (§45B)
- the new qualified plug-in electric vehicle credit (§30D, through 2013)
- the small employer health insurance credit (§45R)
Additional business tax credits are available for certain trade, business or for-profit activities. Your CPA or tax accountant will be able to help determine the types of tax credits that your business qualifies for. Additionally, other tax credits that don’t relate to specific business activity could include credits for:
- withheld taxes
- estimated taxes paid
- excess employment tax withholding
- foreign tax credit
- and more.
As you can tell, the world of tax credits is vast — and can be extremely complex for individuals and business owners who are unfamiliar with tax law. While it can be confusing, it’s a mistake to not try to take full advantage of every applicable tax credit for you or your business! When applied correctly, a tax credit could save you valuable money that can fuel the growth of your business.
To ensure you are making the most of the tax credits available to you, contact our firm now. We would be happy to help you find even more ways to reduce your annual tax liability and keep more money in your pocket.