Every year, taxpayers frequently overlook money-saving tax credits, even when they’re perfectly qualified for some of these credits. I’ve done this enough times that I’ve OFFICIALLY learned my lesson. Don’t let this costly mistake happen to you when filing your 2014 taxes—knowledge is power (and in the case of tax credits, a powerful money-saving tax break).
The difference between “tax credit” and “tax deduction”
First things first, understanding the difference between a tax credit and tax deduction is essential to maximizing your tax savings.
Tax deductions result in a reduction of your taxable income. Since they’re calculated using your tax bracket, you deduct in an amount proportional to your income. For example, if you’re in the 28% tax rate bracket and claimed a $1000 tax deduction on your tax return, the tax deduction lowers your taxable income by $280 ($1000 x .28 = $280).
On the other hand, tax credits reduce your tax liability on a dollar-for-dollar basis. For example, if you take a $1000 tax credit, that means you’ll pay $1000 less in taxes. If you qualify for any tax credit(s), you can claim said credit(s), regardless of whether you itemize your deductions.
Saver’s Tax Credit
The Saver’s Credit, previously known as the Retirement Savings Contribution Credit, is intended to give a tax break to low and moderate income taxpayers who make eligible contributions to retirement savings plans. According to a study by Transamerica Center for Retirement Studies, a mere 12% of American workers with household incomes under $50,000 were aware of this tax credit. This year when filing your taxes, make sure you’re one of the informed!
- Who’s eligible? To be eligible for the Saver’s Credit, you must: (1) be at least 18; (2) not be a full-time student; (3) not be claimed as a dependent on someone else’s tax return; (4) make eligible contributions into an eligible retirement savings plan (see below); and (5) have an adjusted gross income of $30,000 or less (if you’re filing as single, married filing separately or a qualified widow(er)), $45,000 or less (filing as head of household), or $60,000 or less (married filing jointly).
- Eligible retirement savings contributions: According to the IRS, the 2014 Saver's Credit can be taken for your contributions to a traditional or Roth IRA; your 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and your voluntary after-tax employee contributions to your qualified retirement and 403(b) plans.
- Amount of the credit: Depending on your tax filing status and adjusted gross income, the amount of the Saver’s Credit is 50%, 20% or 10% of the first $2000 you contribute to eligible retirement savings contributions. Accordingly, the maximum amount of the tax credit is $1000, $400 or $200. See the chart below for more information:
The Federal Earned Income Tax Credit (EITC)
The federal EITC can be one of the most beneficial tax credits for low and moderate income taxpayers. However, even though this tax credit has been around since 1975, many qualified taxpayers don’t claim it, potentially missing out on a significant tax credit that could reduce your tax liability by thousands of dollars.
- Who’s eligible? To be eligible for the EITC, you must have earned income within certain limits from employment, self-employment or another qualified source; have an adjusted gross income within certain limits; and meet other basic eligibility rules. After you meet the basic rules, you must either meet the additional rules for those without a qualifying child or have a child that meets all the qualifying child rules for you or your spouse if you file a joint return. Still unsure? Use the IRS’s EITC Assistant Tool, which will help you find out if you’re eligible for the EITC through answering questions and providing basic income information. The EITC Assistant Tool also estimates the amount of your EITC.
- Amount of the credit: The amount of the EITC varies depending on your income and your family size. For the 2014 tax year, the maximum EITC is: $6,143 with three or more qualifying children; $5,460 with two qualifying children; $3,305 with one qualifying child; and $496 with no qualifying children.
State and Local EITC credits
The EITC discussed in the section above is a federal tax credit. If you qualify for the federal EITC, you may also qualify for your state and local credits. Twenty-five states, New York City, the District of Columbia and Montgomery County, Maryland offer their residents an earned income tax credit. To learn more about these state and local EITC credits, click here.
Energy-Saving Tax Credits
It can pay to go green. If you made eligible energy-saving improvements to you home located in the U.S. during 2014, you may be able to claim the Residential Energy Efficient Property credit on your 2014 tax return.
- You may be able to take a credit of 30% of your costs of qualified solar electric property, solar water heating property, small wind energy property, geothermal heat pump property and fuel cell property. You can also include any labor costs properly allocable to the onsite preparation, assembly, or original installation of the residential energy efficient property and for piping or wiring to interconnect such property to the home. The credit amount for costs paid for qualified fuel cell property is limited to $500 for each one-half kilowatt of capacity of the property.
- You can verify your qualifying equipment at the U.S. Department of Energy’s Energystar website.
- For more information, check out the IRS Instructions for Form 5695.
Other Tax Credits
Don’t overlook these tax credits that have been previously discussed in recent KCL articles:
- Education tax credits: The American Opportunity Tax Credit (AOTC) and the Lifelong Learning Credit (LLC) (check out this KCL article for more information).
- Child and Dependent Care Expenses Credit: Check out this KCL article for more information.
- Child Tax Credit: Check out this KCL article for more information.