Nobody likes paying more tax than they have to, and tax credits are one of the most effective ways Americans can reduce their tax liability and boost their tax refunds. In fact, Americans use tax credits to save billions of dollars on their taxes every year.
However, some of the most common tax credits aren’t well-understood by millions of Americans, so here’s a quick guide to what tax credits are and how you could take advantage of some of the most common and lucrative credits available.
(Note: All dollar amounts in this article are current for the 2020 tax year, which is the tax return you’ll file in 2021. If you’re looking for information for the tax return you’ll file in 2020, you’ll want to look for 2019 tax credit information instead.)
What is a tax credit?
A tax credit is a form of tax incentive that is designed to encourage a certain activity, or to ease the financial burden on American families associated with certain situations. For example, the Child Tax Credit is intended to help cover the high costs of raising a child in the United States, while the Lifetime Learning Credit is designed to encourage Americans to pursue educational opportunities.
Unlike a tax deduction, which reduces your taxable income, a tax credit reduces your tax liability dollar-for-dollar. If you calculate your taxable income and apply the 2020 tax brackets, and find that you owe the IRS $5,000, a $1,000 tax credit would reduce your tax liability to $4,000.
Refundable tax credits
One major distinction that you’ll see throughout this discussion is that some tax credits are refundable, while others are nonrefundable.
A refundable tax credit can be paid to the taxpayer, even if they have no tax liability. For example, if a taxpayer owes $1,000 in federal income tax in 2020 and has a $3,000 refundable tax credit, that additional $2,000 can be paid to them in the form of a tax refund. On the other hand, a non-refundable credit can be used to reduce tax liability to zero, but not beyond that point.
The most common U.S. tax credits
There is a long list of tax credits Americans could potentially qualify for, but many are very specialized and uncommon. On the other hand, there are some tax credits that millions of Americans qualify for, and here are eight 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)
Because these are such commonly used tax credits, let’s take a closer look at each one…
The 2020 Child Tax Credit
The Child Tax Credit is available to taxpayers who have children who are under age 17 at the end of the tax year. For 2020, this means that any children who reach their 17th birthday prior to January 1, 2021 are not eligible for the credit.
The credit is worth $2,000 per qualifying child, and households with qualifying children can claim the Child Tax Credit for every child who qualifies with no upper limit. For example, if you have three children ages 14, 12, and 9, you can take the credit for each of them – a total of $6,000. A family with six qualifying children could get $12,000 in credits.
The Child Tax Credit is an example of a partially refundable tax credit. If the taxpayer has zero tax liability in a given year, as much as $1,400 of the Child Tax Credit can still be given to them.
Like many tax credits, the Child Tax Credit is income-restricted, although the limitations have become much more generous in recent years as a result of the Tax Cuts and Jobs Act. Above certain levels of adjusted gross income, or AGI, the credit begins to phase out – meaning that it is reduced – and if the taxpayer’s AGI is greater than an even higher threshold, the credit disappears entirely. 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.
| Tax Filing Status | Maximum AGI for the Full Child Tax Credit (Phase-Out Threshold) | AGI Where Child Tax Credit Disappears |
|---|---|---|
| Single | $200,000 | $240,000 |
| Married Filing Jointly | $400,000 | $440,000 |
| Head of Household | $200,000 | $240,000 |
| Married Filing Separately | $200,000 | $240,000 |
Here’s how this works. Let’s say you’re a married couple filing a joint tax return, and that you have qualifying children. If your adjusted gross income is $150,000 in 2020, you’re well below the phase-out threshold, and you’d be entitled to the full Child Tax Credit. If your AGI is $425,000, you’re in the middle of the two thresholds, and would therefore be entitled to some of the credit. And if your AGI is $500,000 for the year, you’d be in excess of the upper threshold for your filing status and wouldn’t be allowed to claim the Child Tax Credit at all for the 2020 tax year.
Credit for other dependents
The Child Tax Credit is a big help to many parents, but what if your child is 17? What if you have kids in college who you support? Or what if you have an aging parent who lives with you?
The point is that the Child Tax Credit doesn’t provide relief to everyone with dependents. That’s where the Credit for Other Dependents comes in. This 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 qualifying dependent.
To be perfectly clear, you cannot claim the Child Tax Credit and the Credit for Other Dependents for the same person. And while the $500 credit is one-fourth 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
Child care in the United States is expensive. The national average cost is $11,666 per year for each child, but this can vary dramatically by the type of day care center and its location.
To help provide some relief, parents of children in day care can use the Child and Dependent Care Credit to help offset some of the costs.
To qualify for the Child and Dependent Care Credit, the following conditions must be met:
- You (and your spouse, if applicable) must have earned income. The credit is designed to help people who need child care, so it is only available to working adults. (Note: If you’re disabled or attending school full-time, this requirement doesn’t apply.)
- You paid for child care for a child under age 13. This age limitation doesn’t apply if your dependent is disabled.
- You don’t file your tax return with the Married Filing Separately status.
The child care expenses don’t necessarily need to be paid to a business. In other words, if you employ someone to come to your home to watch your children, those expenses could qualify. However, the person you’re paying cannot be another one of your dependents. For example, you can’t pay your 19-year-old who is home from college to watch your 10-year-old 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. The percentage that applies to you depends on your AGI. If your AGI is $15,000 or less, you can use the credit for 35% of qualifying expenses, and the percentage drops by one for every $2,000 in additional AGI – 34% for up to $17,000 in AGI, 33% for up to $19,000, etc.
However, the lowest percentage you can qualify for is 20%, regardless of how high your AGI is.
Finally, if you use a dependent care flexible spending account (FSA) through your employer to help cover child care costs, you can’t use those funds and the Child and Dependent Care Credit to pay for the same expenses. However, since the credit maxes out at $3,000 in expenses per child and the dependent care FSA limit is $5,000 per year, it’s fair to assume that many parents can combine these two tax benefits.
The 2020 Earned Income Tax Credit (EITC)
The Earned Income Tax Credit, or EITC, is one of the few fully refundable tax credits in the United States Tax Code. Designed to reduce the financial burden on lower-income workers, particularly those with children, the EITC can be worth thousands of dollars for larger families of modest incomes.
As the name implies, the EITC is only available to taxpayers who have earned income for the year – which means income from a job or self-employment activities. And families can have no more than $3,650 in investment income, or they’re ineligible for the EITC.
For the 2020 tax year, here’s a quick guide to the maximum AGI to be eligible for the credit, as well as the maximum credit that families of various sizes could qualify for:
| Number of Qualifying Children | AGI Limit: Married Filing Jointly | AGI Limit: Single or Head of Household | Maximum EITC for 2020 Tax Year |
|---|---|---|---|
| 0 | $21,710 | $15,820 | $538 |
| 1 | $47,646 | $41,756 | $3,584 |
| 2 | $53,330 | $47,440 | $5,920 |
| 3 or more | $56,844 | $50,594 | $6,660 |
The 2020 Retirement Contribution Savings Credit (Saver’s Credit)
The Saver’s Credit is designed to encourage low- to moderate-income households to save money for retirement.
If your AGI is within the IRS limitations for the credit, the Saver’s Credit is worth 10%, 20%, or 50% of qualified retirement account contributions. Retirement contributions of as much as $2,000 per person to tax-advantaged retirement plans such as IRAs, 401(k)s, 403(b)s, 457s, Thrift Savings, SEP-IRA, and SIMPLE IRAs qualify, just to name some of the most common options. And the account can either be tax-deferred, or of the Roth variety.
Here’s a quick guide to the 2020 Saver’s Credit income limitations for different tax filing statuses:
| Credit — % of contributions | Married Filing Jointly | Head of Household | All Other Filers |
|---|---|---|---|
| 50% of contribution | Up to $39,000 | Up to $29,500 | Up to $19,500 |
| 20% of contribution | $39,001-$42,500 | $29,501-$31,875 | $19,501-$21,250 |
| 10% of contribution | $42,501-$65,000 | $31,876-$48,750 | $21,251-$32,500 |
| No credit | AGI over $65,000 | AGI over $48,750 | AGI over $32,500 |
As an example, let’s say that you’re single and have AGI of $30,000 for 2020. According to the chart, this allows you to deduct 10% of your first $2,000 in retirement contributions. So, if you contribute $2,000 (or more) into your IRA or employer’s retirement plan in 2020, you qualify for a tax credit of $200.
American Opportunity Tax Credit (AOTC)
The more lucrative of the two education tax credits available to Americans who paid tuition, the American Opportunity Tax Credit (AOTC) is also the tougher of the two to qualify for.
In order to qualify for the AOTC (not an exhaustive list of the requirements):
- The student who the tuition was paid for must be pursuing a degree, certificate, or other credential.
- The student needs to be enrolled on at least a half-time basis.
- The student must be completing one of their first four years of post-secondary education.
In addition, the AOTC has income restrictions. The taxpayer claiming the credit must have modified AGI of $160,000 or less if filing a joint return, or $80,000 or less if they file under any other status, in order to receive the full credit. If the taxpayer has modified AGI of more than $180,000 (joint) or $90,000 (all others), they can’t claim the credit at all.
If qualified, the AOTC is worth:
- 100% of the first $2,000 of qualified higher education expenses
- 25% of the next $2,000 of qualified higher education expenses
This means that the maximum AOTC is $2,500 per qualified student per year. Parents who pay tuition for more than one qualifying student can claim the AOTC for each one. Finally, the AOTC is a partially refundable tax credit – as much as $1,000 of the credit can be paid to taxpayers, even if they have no tax liability at all.
Lifetime Learning Credit (LLC)
The Lifetime Learning Credit is designed for Americans who paid tuition and other qualifying higher education expenses, but don’t meet the restrictions designated by the AOTC. Specifically, the LLC is most commonly used by taxpayers who paid tuition for a student who is beyond their fourth year of post-secondary education or who is not enrolled in a degree- or certificate-seeking program.
The LLC can be taken for almost any higher education expenses, even if you take a single course at your local college for no other reason than you were interested in the subject matter.
On the other hand, the LLC is significantly more restrictive than the AOTC when it comes to income. Taxpayers must have AGI of $118,000 or less (joint filers) or $59,000 or less (all others) in 2020 to claim their full LLC. The credit disappears entirely for AGI over $138,000 or $69,000, respectively.
If you qualify, the LLC is worth 20% of as much as $10,000 in qualified higher education expenses. So, if you paid $4,000 in tuition and other qualifying expenses in 2020, the LLC could reduce your tax bill by as much as $800.
Federal Adoption Tax Credit
Last but certainly not least, the Federal Adoption Tax Credit is one of the most lucrative tax credits for households who qualify. The 2020 Federal Adoption Tax Credit is worth as much as $14,300 per child, which can certainly ease the financial burden of adopting (which anyone who’s done it can tell you – it’s not cheap).
The credit can be taken for either the maximum amount or your actual adoption-related expenses, whichever is lower. Qualified expenses can include adoption agency fees, legal expenses, and travel costs, just to name a few.
Like many of the tax credits on this list, the Federal Adoption Tax Credit is income-restricted, meaning that high-income taxpayers can’t use it. For the 2020 tax year, the maximum AGI that can qualify for the full adoption credit is $214,520 (regardless of filing status), and the deduction phases out entirely for taxpayers with AGI over $254,520.
There are other (less common) tax credits
To be clear, this is not intended to be a full list of every tax deduction available in the United States, just an in-depth look at eight of the most common. There are other tax credits that might apply to you, such as:
- 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
Defer to the experts
As a final thought, it’s important to mention that there is quite a bit of grey area in the U.S. tax code, and that’s especially true when it comes to these credits. If you’re uncertain about your ability to claim any of the credits, or how much you might be entitled to, it’s a smart idea to seek the advice of an experienced CPA or tax professional before completing your 2020 tax return.