How Tax Credits Work

Want to learn how tax credits work? Each year during tax time, the process begins to get the largest return. Knowing how tax credits work can make this task easier.  This term may be a bit confusing since there are many terms thrown out during tax season such as tax deduction and tax allowance in addition to a tax credit.  A tax credit is the most valuable and the most sought after because of how tax credits work.

How tax credits work is a simple concept once all of the terms involved are understood.  A tax credit reduces the amount of tax owed.  Each tax payer is responsible for paying a certain amount of taxes each year.  If they are able to claim a tax credit, the amount of the tax they owe is reduced by the amount of the tax credit.  How tax credits work is that they are looked at as a partial payment on the amount of owed taxes.

Tax credits are characterized into two different categories.  There are refundable or non-wasteable and nonrefundable or wasteable tax credits.  Each category has its own set of tax credits and to be able to claim them, certain criteria must be met.

A refundable or non-wasteable tax credit is a type of tax credit that can reduce the amount of tax owed below zero.  If the tax liability zeros out and there is still tax credit left to be claimed, this will result in a refund to the tax payer.  Examples of this type of tax credit are the Earned Income Tax Credit and the Child Tax Credit.

A nonrefundable or wasteable tax credit is a type of tax credit that cannot reduce the tax owed below zero.  If there is still credit to be claimed after the tax liability reaches zero, the rest is forfeited and this type of tax credit will not result in a refund.  An example of this type of tax credit is the Savers Tax Credit.

There are many different types of tax credits available to be claimed.  There are tax credits for housing, schooling, child care, and retirement, to name a few.  To qualify for these tax credits certain criteria must be met, but if they are applied to your tax refund, they can result in a tax refund and money in your pocket.