A tax credit is a sum deducted from the total amount a taxpayer owes to the state. A tax credit may be granted for various types of taxes, such as an income tax, or property tax. It may be granted in recognition of taxes already paid, as a subsidy, or to encourage investment or other behaviors.Sometimes tax credits are 'refundable to the extent they exceed the relevant tax. Tax systems may grant tax credits to businesses or individuals, and such grants vary by type of credit.
Credit for payments
Income taxation systems refer to taxes paid indirectly, such as taxes withheld by payers of income, as credits rather than prepayments. In such cases, the tax credit is invariably refundable. The most common forms of such amounts are payroll withholding of income tax, and withholding of tax at source on payments to nonresidents.
A credit for Federal highway use tax paid with respect to gasoline or diesel fuel for vehicle use off highways, may be claimed as a payment of on federal income tax returns.
Individual income tax credits
Low income subsidies
Federal and most states provide income subsidies to lower income individuals by way of credit. These credits may be based on income, family status, work status, or other factors. Often such credits are refundable when total credits exceed tax liability.
The U.S. system grants the following low income tax credits:
- Earned income credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2009, the maximum credit was $5,657.
- Credit for the elderly and disabled: A nonrefundable credit up to $1,125
- Retirement savings credit: a nonrefundable credit of up to 50% of contributions to IRAs or similar plans, phased out at incomes above $16,000 ($24,000 for head of household and $32,000 for joint returns).
- Mortgage interest credit: a nonrefundable credit that may be limited to $2,000, granted under specific mortgage programs.
Some systems grant tax credits for families with children. These credits may be on a per child basis or as a credit for child care expenses.
The U.S. system offers the following nonrefundable family related income tax credits (in addition to a tax deduction for each dependent child):
- child credit: a credit up to $1,000 per qualifying child.
- Child and dependent care credit: a credit up to $6,000, phased out at incomes above $15,000.
- Credit for adoption expenses: a credit up to $10,000, phased out at higher incomes.
Education, energy and other subsidies
Federal indirectly subsidize education and similar expenses through tax credits.
The U.S. system has the following nonrefundable credits:
- Two mutually exclusive credits for qualified tuition and related expenses. The American Opportunity Tax Credit is 100% of the first $2,000 and 25% of the next $4000 of qualified tuition expenses per year for up to two years. The Lifetime Learning Credit is 20% of the first $10,000 of cumulative expenses. These credits are phased out at incomes above $50,000 ($100,000 for joint returns). Expenses for which a credit is claimed are not eligible for tax deduction.
- Credits for purchase of certain nonbusiness energy property and residential energy efficiency. Several credits apply with differing rules.
Business tax credits
The federal government and many states offer various incentives for businesses to make investments in property or operate in particular areas. Credits may be offered against income or property taxes, and are generally nonrefundable to the extent they exceed taxes otherwise due. The credits may be offered to individuals as well as entities. The nature of the credits available varies highly by jurisdiction.