Five Common Tax Credits Explained
1. Credit for Child and Dependent Care Expenses. The credit for child and dependent care expenses can be fairly significant, depending on the amount that you paid and your income level. The credit is equal to a percentage of the expenses you actually paid for child care less any reimbursements from any program or social services agency. The credit starts at 35% of expenses if your adjusted gross income is less than $15,000 and phases out to 20% of expenses if your adjusted gross income is more than $43,000. The maximum credit available is $3,000 for one qualifying child and $6,000 for two or more qualifying children.
If you have out-of-home child care at a qualifying child care center, the center must meet federal and state requirements and have a total enrollment of at least six children. To claim the credit, you report the amount paid, together with the tax ID number of the child care center, on your tax return using a federal form 2441.If you have home child care, the rules are significantly different. The IRS requires you to treat most home child care workers as household employees (among the exemptions are part-time babysitters under the age of 18). This means the workers must be eligible to work in the U.S. (so certain foreign students and others might not qualify), and you may be responsible for payroll taxes.
The credit for child and dependent expenses is one of the more complicated credits to figure out. Phaseouts, income restrictions and other criteria apply. Check IRS Publication 503 for more details.
2. Education Credits. Two credits allow students to recover costs associated with getting an education: the Lifetime Learning Credit and the American Opportunity Credit. You can only elect to use one credit per year, but not both.
The Lifetime Learning Credit allows a credit of up to $2,000 ($4,000 for students in Midwestern disaster areas) for qualified education expenses for all students enrolled in eligible educational institutions. Just as the name implies, there's no limit on the number of years the Lifetime Learning Credit can be claimed, and you don't need to pursue a degree in order to qualify.
The American Opportunity Credit is a credit that modifies the existing Hope Credit for the tax year 2010 (and for the next two years as part of The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010). The credit, which is a maximum credit of up to $2,500 per student, is available to students for four post-secondary education years who are pursuing a degree. Income restrictions apply -- the full credit is available to individuals whose modified adjusted gross income is $80,000 or less or $160,000 or less for married couples filing a joint return. The credit is phased out for taxpayers with incomes above these levels.
3. Earned Income Tax Credit. The Earned Income Tax Credit (EITC) is a refundable federal income tax credit for low to moderate income working individuals and families. To qualify for the credit, you must have earned income from wages or from self-employment, but your investment income cannot exceed $3,100.
You must either have a qualifying child or be between age 25 and 65 while living in the U.S. for more than half the year and not qualify as a dependent of another person. Regardless of income, taxpayers who file as married filing separately do not qualify for the EITC.
Income restrictions apply. Your adjusted gross income (AGI) must be less than:
- $43,352 ($48,362 for married filing jointly) if you have three or more qualifying children,
- $40,363 ($45,373 for married filing jointly) if you have two qualifying children,
- $35,535 ($40,545 for married filing jointly) if you have one qualifying child, or
- $13,460 ($18,470 for married filing jointly) if you do not have a qualifying child.
- $5,666 with three or more qualifying children
- $5,036 with two qualifying children
- $3,050 with one qualifying child
- $457 with no qualifying children
A reduced credit up to $6,500 was also available in 2010 for taxpayers who have lived in their homes at least five consecutive years out of the eight years before buying and moving into a new principal residence.
To claim the credit, if you did not claim the credit on your 2009 return, you must attach to your tax return a copy of Form HUD-1, Settlement Statement or other settlement statement, showing all parties' names and signatures, property address, sales price and date of purchase. You must also complete a form 5405, First-Time Homebuyer Credit and Repayment of the Credit.
Also notable for 2010: The first-time homebuyer credit for 2008 established under The Housing and Economic Recovery Act of 2008 was the equivalent of a no-interest loan worth up to $7,500 which must be repaid in 15 equal, annual installments. The first installment is due with your 2010 income tax return.
5. Making Work Pay Credit. For 2010, taxpayers will receive a refundable tax credit of up to $400 for working individuals and up to $800 for married taxpayers filing joint returns. The credit is equal to 6.2% of earned income and will phase out for taxpayers with modified adjusted gross income in excess of $75,000, or $150,000 for married couples filing jointly.
For most taxpayers, the credit will be handled by their employers through automatic withholding reductions, which should put more money into the hands of taxpayers each pay period. The actual amount of the credit will be computed on your 2010 income tax return; self-employed persons or others not subject to withholding can claim the credit at that time. Those who are unemployed do not qualify for the credit.
2010 marks the last year for this credit: it was not renewed under The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
Other credits, including the energy credit, child tax credit and credit for foreign taxes paid, are available for qualifying taxpayers. Be sure and familiarize yourself with the available credits so you don't miss out.