The 5 Most Popular Tax Credits: Can You Use Them, Too?
To help you home in on the credits that are most likely to help you, we looked at the latest data from the IRS -- from the 2012 tax year -- to see which credits people are most likely to take.
5. Retirement Savings Contributions Credit
More than 6.9 million taxpayers took the retirement savings contributions credit, which matches up to 50 percent of the first $2,000 in contributions that single filers make to an IRA or an employer-sponsored retirement plan at work, or $4,000 for joint filers. The dollar value of those credits was relatively low at just $1.2 billion, but that nevertheless saved an average of about $175 per taxpayer in tax liability.
The credit is only available to single filers making less than $30,000 or joint filers making less than $60,000, and the highest percentages apply only to those who meet even smaller income limits of $18,000 and $36,000, respectively. The purpose of the credit is to encourage everyone to save, and so if you set money aside, this credit is your reward for being financially prudent.
4. Foreign Tax Credit
About 7.1 million taxpayers claimed the foreign tax credit. But even though not many more people claimed it than the retirement savings contributions credit, the foreign tax credit had a much more significant financial impact, saving taxpayers $19.1 billion.
The foreign tax credit is intended to avoid double taxation on income earned from another country. It most often applies to international investments, where many brokers withhold foreign taxes automatically. For those whose only exposure to international investments is through mutual funds, it's sometimes possible to take a full credit against your U.S. taxes for any foreign taxes you pay. Yet complex rules can apply in more complicated situations, so this is an area where a good tax advisor can be extremely helpful.
3. Education Credits
More than 10 million taxpayers took advantage of credits designed to offset college and other educational costs. The vast majority of those taking educational credits used the American Opportunity Tax Credit, which applies to the first four years of college and can reduce your tax bill by up to $2,500. In some cases, you can get a portion of the American Opportunity Tax Credit back as part of your refund even if you didn't have enough tax liability to apply against it.
When you also combine the Lifetime Learning Credit, which pays 20 percent of up to $10,000 in annual educational costs for a wider range of schooling including graduate school and training classes, taxpayers collected about $19.3 billion from education credits, of which $8.8 billion was refundable. Those amounts make a huge difference to cash-strapped families sending kids to college.
2. Child Tax Credits
Families benefit from credits for having qualifying children, with 22.9 million taxpayers claiming the regular child tax credit and 20.5 million using the additional child tax credit as well. Combined, those two credits returned $55.4 billion to taxpayers.
The regular child tax credit pays up to $1,000 for qualifying children under age 17, of which there were more than 70 million, with phase-outs starting for singles earning $75,000 or more and joint filers with incomes of $110,000. Because the regular child tax credit is nonrefundable, the additional child tax credit fills in the gap for lower-income taxpayers, offering a refundable credit to those who have sufficient job income that makes up for any lost regular child tax credit amounts.
1. Earned Income Tax Credit
The most often-taken credit is the Earned Income Tax Credit, which appeared on 27.8 million returns. It's also a hugely important credit for Americans, paying out more than $1.02 trillion, or almost $3,700 per taxpayer claiming the credit.
The Earned Income Tax Credit is aimed at low- and middle-income taxpayers, with the highest amounts paid to those who have eligible children. It's also one of the few credits that is fully refundable, meaning that you can get a refund for up to the full amount of the credit even if you don't have any tax liability against which to apply it.
Credits are extremely valuable for taxpayers, and you should do everything you can to find credits you qualify for. If you do, they'll do a great job of reducing your tax liability as much as possible. We have also compiled a list of the most popular tax deductions.
Motley Fool contributor Dan Caplinger gives credit where credit is due. You can follow him on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.