What is a Tax Credit?

It can be daunting to file your U.S. taxes in a difficult year as 2020. You’re looking to save money where you can and hopefully get some tax money back. It can get even more confusing when you’re a non-citizen residing and working in the U.S.

That’s why it’s important to have a good grasp on what tax credits you qualify for – whether it’s for looking after your children, furthering your education, making smart environmental choices in your home, or needing a little extra help while looking for new work.

Here we explore what is tax credit, how they work, the different types of tax credits, and what tax credits you as an H1B visa holder qualify for.

What is a Tax Credit?

The simplest definition of a tax credit is that it is the sum total of all the reductions you can make on your total tax bill owed to the U.S. government. 

To qualify for these tax credits, you would have had to incur certain expenses during the taxable financial year. These expenses must be considered beneficial to society, the economy, or the environment according to the government’s standards.

This can include looking after children or your parents, pursuing educational endeavors, or even installing renewable energy systems in your home.

How Tax Credits Work

The value of each tax credit varies depending on the activity. It can also differ between states, classifications, and industries. 

Importantly, tax credits are not the same as tax deductions. This is an important distinction, especially when it comes to student loan tax credits and deductions.. Tax deductions only lower your taxable income amount and are dependent on the tax bracket you find yourself in. A tax credit is seen as more beneficial as it applies to your entire tax bill dollar-for-dollar. Tax credits can even result in a tax refund!

For example, if your tax liability in the U.S. is $500, and your total tax credits also amount to $500, the money owed to the government is zero. However, if your tax credits total is $1,000, and the tax credits are refundable tax credits (see below), you’ll be entitled to a $500 refund. 

Types of Tax Credits

Keep in mind not all tax credits are created equal. They fall into three main categories:

1. Non-refundable tax credits
2. Refundable tax credits, and
3. Partially-refundable tax credits.

Let’s take a closer look at each. 

Non-Refundable Tax Credits

While all credits can accumulate to reduce your tax bill to zero, not all of them qualify you for tax refunds if your tax credits exceed your tax bill. This is the case with non-refundable tax credits. If your non-refundable tax credits exceed what you owe the government, that extra tax cut is essentially just written off and doesn’t form part of your refund. 

Non-refundable tax credits also can’t be carried over to the following tax year. This means if the credit overlaps a financial year you won’t be able to claim the full amount. 

Here are some examples of non-refundable tax credits:

• Adoption credit
• Lifetime learning credit
• Child and dependent care credit
• Saver’s tax credit used for retirement savings, and
• Mortgage interest credit.

Refundable Tax Credits

This is the type of tax credit most useful to taxpayers. Refundable tax credits will be refunded in full if your total tax credits exceed your tax liability. 

The most well-known refundable tax credit is the “earned income tax credit“. This tax credit is designed for lower-income taxpayers. The amount of credit you receive is dependent on your income and the number of family members you care for. Another example is the “premium tax credit” that’s intended to cover health insurance premiums. 

It’s also important to note the government’s stimulus package of $1,200 ($2,400 for couples) issued to help alleviate the financial burdens of the COVID-19 pandemic is an advance refundable tax credit and won’t be taxed for this year. 

Partially-Refundable Tax Credits

Partially-refundable tax credits only refund a portion of the full credit if it reduces the tax bill beyond zero. 

A good example is the “child tax credit“. The amount of the credit can vary, but only a maximum of $1,400 is refundable. In the case of the “American opportunity tax credit“, if the full amount of your tax credit reduces your tax bill beyond zero, only 40% of the exceeding credit will be refunded – up to a maximum of $1,000.

Tax Credits for H1B Visa Holder

For those working in the U.S. due to their special skills, taxes tend to be similar to that of U.S. citizens. If you are an H1B visa holder, you can make a claim on a variety of tax credits when filing your taxes. 

These can include:

• Child tax credit
• Education credits
• Foreign tax credits
• Credits for the elderly and differently-abled people
• Earned income credits
• Adoption credits, and
• Child and dependent care credits.

These tax credits are similar to itemized deductions on income tax which you can also use to reduce your tax bill. As an H1B visa holder, you can claim these deductions through Schedule A of Form 1040. Some of the deductions you can claim include state and local income taxes, casualty and theft losses, and medical expenses.

It’s also important to keep in mind you get more tax benefits if you file your taxes as a family. So, if you can, consider filing your taxes together. 

A good example here is the “child tax credit”. You could receive a credit of up to $1,000 per qualifying child who is residing with you in the U.S. An “additional child tax credit” will apply if your tax liability is lower than this tax credit. If so, a portion will be refunded. There’s also an additional tax credit if your child is adopted. However, this is a non-refundable tax credit.

You could also qualify for a “child and dependent care credit” if you’ve been caring for a loved one while unemployed or looking for new employment. If you’re married, however, and filing your taxes jointly, this credit is only applicable if you are working or registered as a full-time student at college. You will also only be able to submit joint taxes if your spouse resides in the U.S. full-time.

Conclusion

Understanding what is tax credit will help you manage your finances far more effectively than before. 

The next step is to take a look at the complete U.S. list of tax credits, make a list of the ones you might qualify for, and ensure you have all your documentation in order when filing your taxes.

If you’re feeling unsure about doing it on your own, reach out to a tax professional to help you make sense of it all and better save for the future.

Frank Gogol

I’m a firm believer that information is the key to financial freedom. On the Stilt Blog, I write about the complex topics — like finance, immigration, and technology — to help immigrants make the most of their lives in the U.S. Our content and brand have been featured in Forbes, TechCrunch, VentureBeat, and more.

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