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When it comes to taxes, credits are the preferred way to cut your bill.
While deductions, either itemized or standard, reduce your amount of taxable income, credits cut your actual tax bill, dollar-for-dollar. That’s because credits come into play AFTER your tax liability is figured. So if you owe Uncle Sam $500, a $250 tax credit will cut your bill in half.
Similarly, some credits are more valuable than others.
Refundable credits
Refundable credits may eliminate any tax you owe and provide you with a refund. So even if your tax bill is zero, you could get money back from the Internal Revenue Service thanks to a refundable credit. These credits include:
- Earned income tax credit
- Additional child tax credit
- Credit for taxes withheld on wages and other amounts
Nonrefundable credits can take your tax down to nothing, but you can’t get money back from the government. Popular nonrefundable credits are:
- Child tax credit
- Child- and dependent-care credit
- Credit for the elderly or disabled
- Retirement savings contributions credit
- Adoption expenses credit
- Hope and Lifetime Learning education credits
These credits can’t be used to get a refund on your tax return. When your tax bill reaches zero, any leftover credit amount is wasted. With the adoption credit, however, you can carry forward unused amounts from year to year until the credit is absorbed or the carry-forward period expires, whichever is first.
The choice of your tax form also could affect your credit claims. Form 1040EZ filers can only claim the earned income credit. To get the benefit of the other credits, you must use Form 1040 or Form 1040A, and some of these credits require you to fill out additional forms.
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