What is Tax credit?

A tax credit reduces your tax bill dollar for dollar. It’s more valuable than a deduction, which only reduces the income you’re taxed on. Unlike tax deductions, which reduce the amount of taxable income, tax credits reduce the actual tax owed on a dollar-for-dollar basis, making them significantly more valuable than deductions. Tax credits are established by Congress to incentivize activities such as education, energy efficiency, child-rearing, and retirement savings.

Tax credits are classified as nonrefundable or refundable. Nonrefundable credits (such as the Lifetime Learning Credit or Child and Dependent Care Credit) can reduce a taxpayer's liability to zero, but any excess credit is forfeited. Refundable credits (such as the Earned Income Tax Credit or the Child Tax Credit) can reduce liability below zero, resulting in the IRS sending the remaining credit balance to the taxpayer as a refund.

Common federal tax credits include the Child Tax Credit, education credits, and clean vehicle credits. The income thresholds and credit amounts are adjusted periodically for inflation.