What a Tax Credit Is and How It Works

A tax credit reduces the taxes you owe, dollar for dollar

A tax credit is an amount of money that directly lowers the federal income tax you owe to the IRS. If you owe $2,000 in taxes and you have a $500 tax credit, you now owe $1,500. A credit is different from a deduction, which only reduces the income the IRS counts — a deduction saves you money based on your tax rate, but a credit saves you the full amount.

Tax credits come from the federal government and are written into the tax code. You claim them on your tax return, usually on Form 1040 or a related schedule. The IRS then subtracts the credit from what you owe. If a credit is larger than what you owe, some credits will send you the difference as a refund — these are called refundable credits. Others straightforward reduce your bill to zero and stop there — these are nonrefundable credits.

Key Takeaways

A tax credit subtracts directly from the taxes you owe, while a deduction only reduces your taxable income.
Refundable credits can send you money back if they are larger than what you owe; nonrefundable credits can only reduce your bill to zero.
You claim tax credits on your tax return by filling out the correct form or schedule and sending it to the IRS.
Common credits include the Child Tax Credit, Earned Income Tax Credit, and education credits like the American Opportunity Credit.

Refundable vs. nonrefundable credits

The difference between these two types matters when a credit is larger than your tax bill. If you owe $800 and you have a $1,200 refundable credit, the IRS sends you $400. If that same $1,200 credit is nonrefundable, you owe nothing, but you do not get the extra $400 back.

The Earned Income Tax Credit (EITC) is refundable, which is why it often results in a refund for lower-income workers. The Child Tax Credit is partially refundable — up to $1,700 of the credit per child can be refunded, depending on your income and how many children you have. The American Opportunity Credit, which helps with college costs, is partially refundable as well. Many other credits, like the Lifetime Learning Credit and the Saver's Credit, are nonrefundable.

Common tax credits you may encounter

The Child Tax Credit gives you up to $2,000 per child under age 17. You claim it on Schedule 8812 if you are filing Form 1040. The credit phases out at higher income levels, and the IRS updates the income thresholds each year.

The Earned Income Tax Credit (EITC) is for workers with low to moderate income. The amount depends on your income, filing status, and whether you have children. You claim it on Schedule EIC. This credit is refundable, so many people who claim it receive a refund even if no taxes were withheld from their paychecks.

The American Opportunity Credit covers up to $2,500 of college expenses per student per year — tuition, fees, and course materials. You claim it on Form 8863. Up to $1,000 of this credit is refundable. The Lifetime Learning Credit is another education credit that covers tuition and fees but is nonrefundable and has a lower maximum amount.

The Dependent Care Credit helps you pay for childcare or adult care so you can work. You claim it on Form 2441. The credit is nonrefundable and the amount depends on what you spent and your income.

How to claim a tax credit on your return

First, determine which credits you may be able to claim. The IRS website lists all available credits, and many tax software programs will ask you questions to find credits you may have access to for. Read the requirements for each credit carefully — most have income limits, age limits, or other conditions.

Next, fill out the correct form or schedule. Each credit has its own form. The Child Tax Credit uses Schedule 8812, the EITC uses Schedule EIC, education credits use Form 8863, and so on. These forms ask for information about you, your dependents, or your expenses, depending on the credit.

Attach the completed schedule or form to your Form 1040 when you file. If you are using tax software, the program will guide you through the questions and fill out the forms for you. If you are filing by hand, print the forms, fill them out, and mail them with your return to the IRS address for your state.

The difference between a credit and a deduction

A deduction reduces the amount of income the IRS counts as taxable. If you earn $50,000 and take a $10,000 deduction, the IRS only counts $40,000. Your tax savings depend on your tax rate — if you are in the 22% bracket, that $10,000 deduction saves you $2,200.

A credit saves you the full amount, no matter your tax rate. A $2,200 credit saves you $2,200, whether you are in the 10% bracket or the 37% bracket. This is why credits are usually more valuable than deductions of the same size. However, deductions are easier to claim — you do not need to meet specific requirements the way you do for most credits.

Income limits and phase-outs

Many tax credits shrink or disappear as your income rises. This is called a phase-out. The Child Tax Credit, for example, begins to phase out at $400,000 of income for married couples filing jointly and $200,000 for single filers. The EITC phases out at different income levels depending on your filing status and number of children.

When a credit phases out, you lose a portion of it for each dollar of income above the threshold. The IRS publishes the exact phase-out rates and income limits each year, and they change slightly to account for inflation. If your income is close to a phase-out threshold, calculate your credit carefully or use tax software to make sure you claim the right amount.

Frequently Asked Questions

Can I claim multiple tax credits on the same return?

Yes. You can claim as many credits as you meet the requirements for. For example, you could claim the Child Tax Credit, the EITC, and an education credit all on the same return if you may have access to for each one. However, some credits cannot be combined — the American Opportunity Credit and the Lifetime Learning Credit cannot both be claimed for the same student in the same year.

What happens if my tax credit is bigger than what I owe?

If the credit is refundable, the IRS sends you the difference as a refund. If it is nonrefundable, your tax bill goes to zero and you do not receive the extra amount. Check whether each credit you claim is refundable or nonrefundable.

Do I need to keep receipts or documents to claim a tax credit?

You do not send receipts with your return, but you should keep them for your records in case the IRS asks questions later. For education credits, keep tuition statements and proof of enrollment. For dependent care credits, keep receipts from the care provider. For the EITC, keep pay stubs and proof of income.

Can I claim a tax credit if I did not work?

Most credits require some income or work history. The EITC requires earned income from a job or self-employment. Education credits require you or a dependent to be enrolled in school. The Child Tax Credit does not require work, only that you have a may have access to child. Check the specific requirements for each credit.

This guide is for general information only and is not medical, financial, legal, or other professional advice. For decisions specific to your situation, consult a qualified professional. See our Editorial Policy.