What Are Tax Credits And Which Should You Use For 2023?

A tax credit can help lower the amount you pay in income taxes each year. Say you are raising a young child. You might qualify for the child tax credit of $2,000. That credit will reduce the income taxes that you owe by that same $2,000, a nice bonus when you’re filing your taxes.

But determining which tax credits are available to you and how to claim them can be complicated. It's not easy, either, to understand the differences between a tax credit and deduction.

But don't worry. We can help. Here is your complete guide to tax credits and how they can help you save money each year.

What Are Tax Credits And How Do They Work?

The IRS defines a tax credit as a dollar-for-dollar reduction in the income tax you owe.

That sounds more complicated than it is. Say you qualify for $1,000 in tax credits. The income tax that you owe taxes on will then be reduced by a total of $1,000. If you owed $5,000 in income taxes, your tax credits would reduce your income tax bill to $4,000.

If you can claim enough tax credits, you might also qualify for a refund. This happens when you pay more in taxes throughout the year than what you owe to the federal government or your state government.

When filing your income taxes, you have the chance to itemize your deductions – which are different than tax credits and reduce the amount of your taxable income – or claim the standard deduction. For the 2023 tax year, the standard deduction is $13,850 for single filers and married taxpayers who are filing separately and $27,700 for those married and filing jointly. You can’t both claim individual deductions and the standard deduction.

You don’t have to make this choice, though, when claiming tax credits on your tax return. You can claim both tax credits and the standard deduction when filing your income taxes.

Refundable Tax Credits

Tax credits come in different types, including refundable tax credits. If your tax bill comes out to less than your refundable credit, you'll get the difference back in your refund. Say you owe $1,500 on your tax bill and you qualify for a refundable tax credit of $2,000. You'll get $500 back as a refund.

Partially Refundable Tax Credits

Some tax credits are partially refundable. An example is the American Opportunity Tax Credit. This credit covers qualified education expenses paid by or on the behalf of eligible students for the first 4 years of their higher education. If this credit reduces the tax amount that taxpayers owe to $0, they can get a refund of 40% of the remaining amount of the credit, up to $1,000. Say you qualify for a tax credit of $2,000 through this program and you owe $1,500 in taxes. A total of $1,500 of the credit will be fully refundable. You’d then receive 40% of the remaining $500, or $200, as a refund.

Nonrefundable Tax Credits

Some tax credits don't give you any refund at all. These are known as nonrefundable credits. Say you owe $1,000 on your taxes and you qualify for a nonrefundable tax credit of $2,000. You won't get $1,000 back in a refund. Instead, your overall tax bill will be $0 and you don't get any leftover amount as a refund.

Tax Credit Vs. Deduction

They’re easy to confuse, but a tax deduction is not the same as a tax credit.

While a credit directly reduces the taxes that you owe, a deduction instead reduces your taxable income, also known as your adjusted gross income (AGI).

Tax deductions do lower the amount of income taxes you pay, but because they only lower your taxable income and not your income tax bill directly, they don’t provide as big of a reduction.

Say you qualify for a tax deduction of $1,000. If your adjusted gross income was $70,000 before claiming the deduction, it will be $69,000 after you claim it. You will now pay taxes on $69,000 instead of $70,000.

You can only claim individual deductions if you don’t claim the standard deduction. You’ll have to determine whether you’ll save more money on your taxes by itemizing or taking that standard deduction.

Example Of A Tax Deduction

You can claim several tax deductions. Some of the most common include:

• Medical expenses: You can deduct your qualified unreimbursed medical care expenses that exceed 7.5% of your adjusted gross income. Say your adjusted gross income is $70,000 and you have $6,500 of medical expenses. If you multiply $70,000 by 0.075 (or 7.5%), you'll come up with $5,250. This means that you can deduct medical expenses that exceed that figure. In the example above, you can claim a medical expense deduction of $6,500 minus $5,250, or $1,300.

• Mortgage and student loan interest: You can deduct the interest you pay on the first $750,000 of your mortgage debt ($375,000 if married filing separately). You can also deduct the interest you pay on up to $2,500 of your student loan debt.

• Charitable contributions: You can deduct charitable contributions if you itemize your taxes. The rules for this are complicated, though, and you should consult with your accountant or tax planner when deciding what you can deduct.

• Health care account contributions: Contributions you make to a health savings account (HSA) or a flexible spending account (FSA) are tax deductible if you’re contributing the funds. Contributions made by your employer are not.

• Property taxes: If you are married and filing jointly, you can deduct up to $10,000 of the total property taxes you pay each year. If you are a single filer or married but filing separately, you can deduct up to $5,000 in property tax payments. Say you pay $12,000 in property taxes. If you’re married and filing jointly, you can deduct $10,000.

Guide: Common Tax Credits To Use For 2023

Want to reduce your tax bill? Here are several common tax credits that you might be able to claim for the 2023 tax year.

Adoption Credit

The adoption credit is designed to reduce the financial burden of adopting a child. If you adopted a child or children in 2023, you might be eligible for a credit of up to $15,950 for each child. This is a nonrefundable credit and is only available for families with an adjusted gross income below $239,230.

American Opportunity Tax Credit (AOTC)

Students can claim a tax credit of up to $2,500 to help cover the costs of their first 4 years of higher education. Parents or others can also claim this credit if they are helping a student pay for their tuition, books, supplies or equipment.

Child And Dependent Care Credit

If you paid someone to care for your child or other qualifying individual so that you – and your spouse if you are married and filing your taxes jointly – could either work, look for employment or go to school, you might qualify for the child and dependent care tax credit. The amount you can claim is based on your income and the percentage of the expenses that you took on for child or dependent care.

Child Tax Credit (CTC)

The child tax credit lets you claim a credit of up to $2,000 for every qualifying child you are supporting. Up to $1,600 of this credit is refundable for the 2023 tax year. A qualifying child is typically considered a dependent under the age of 17.

Earned Income Tax Credit (EITC)

If you worked or were self-employed in 2023 and generated an earned income of under $63,698, you might qualify for the Earned Income Tax Credit. If you qualify, you'll receive a $600 credit if you have no dependent children, $3,995 if you have one qualifying child, $6,604 if you have two and $7,430 if you have three or more qualifying dependent children.

Lifetime Learning Credit

The Lifetime Learning Credit can help students cover the cost of undergraduate, graduate or professional degree courses, including courses that they take to learn or improve their career skills. There is no limit on the number of years in which taxpayers can claim this credit. If you qualify, you can earn a credit of up to $2,000.

Mortgage Interest Credit

First-time homebuyers with lower incomes might qualify for a mortgage credit certification, certificates given out by state or local governments. If you qualify for one of these certificates, you can earn a tax credit of up to $2,000 on the mortgage interest that you paid on your home during the year.

Premium Tax Credit

The premium tax credit is a refundable tax credit that helps eligible individuals and families cover the premiums for health insurance plans purchased through the Health Insurance Marketplace. You can qualify for this program if your estimated annual income is between 100% and 400% of the federal poverty level for a household of your size.

Residential Energy Credit

Have you made energy improvements to your home during the year? You might qualify for home energy tax credits. You can claim either the Energy Efficient Home Improvement Credit or the Residential Energy Clean Property Credit in the year in which you make qualifying improvements. Some of the improvements that qualify for this credit include installing energy efficient windows or doors; installing a more efficient central air conditioner, water heater, furnace, boiler or heat pump; ordering a home energy audit; or adding biomass stoves and boilers. The amount you can claim is a percentage of the total improvement expenses. For 2023 through 2032, you can claim 30% of the improvement costs up to a maximum of $1,200 for most improvements.

Retirement Savings Contribution Credit

The retirement savings contribution credit, also known as the Saver’s Credit, rewards you for saving for retirement. If you qualify, you can claim a tax credit for making eligible contributions to your IRA or employer-sponsored retirement plan. You are eligible if you’re 18 or older, not claimed as a dependent on someone else's return and not a student. The amount of the credit varies based on your adjusted gross income and will be 50%, 20% or 10% of your contributions to a retirement plan.

How To Get A Tax Credit In 2023

To get your tax credits, you’ll first have to determine for which credits you might qualify. For most tax credits you’ll need to meet a specific set of requirements. Some credits require that you fill out special IRS forms. Your best bet is to meet with your accountant or tax preparer to determine if you qualify for credits and how you can claim them. If you file your taxes with tax-preparation software, the programs will typically walk you through the process of determining what credits are available to you.