Tax Reduction And Management Techniques - Tax Credits

Tax Credits
Tax credits are direct deductions that reduce the amount of tax liability dollar-for-dollar. Credits are better than normal deductions because they are considered "below the line" subtractions taken directly from the actual tax liability. There are over 17 tax credits currently allowed under the tax code. For study purposes, of those most likely to appear on the exam, we will focus our energy on the five credits listed below:

Children Tax Credit
The current tax law provides an annual tax credit of $1,000 for each qualifying child of the taxpayer that is under age 17 at the end of the tax year, and claimed as a dependent of the tax filer. Qualification for this credit requires filling a Form 2441 with a regular 1040 or 1040A income tax form.

Phase out of the credit applies if your modified adjusted gross income (MAGI) exceeds the following levels:

Single filer
Married, joint filer
Married, separate filer
Head of Household
Qualifying widow/widower

Adoption Expenses Tax Credit
A tax credit of up to $13,170 may be available (2010 figure) on your return if you incurred qualifying costs of adopting a child under age 18, or a person deemed to be mentally or physically incapable of their own care. In order to claim this, you are required to fill Form 8839: qualified adoption expenses.

Phase out of the credit applied if your MAGI is between $182,520 and $222,520 (2010 figures).

Dependent Care Tax Credit
This credit is allowed for reimbursement of expenses to hire a caretaker for a dependent child or other individual while you're at work full or part-time. The credit is available provided that you have earnings from employment.

Limits: Maximum to $3,000 for one dependent, or $6,000 for two or more dependents.
Depending on adjusted gross income (AGI), a credit percentage between 20 to 35% of AGI is used to determine each taxpayer's maximum credit.

These amounts must be reduced if the taxpayer receives an employer dependent care plan.

Phase out for the credit:
AGI over $15,000 up to $43,000: whereas, the 35% credit is reduced 1% for every $2,000 of AGI up to $43,000. At $43,000 AGI + the credit is fixed at 20%.

American Opportunity (Hope) Tax Credit
This credit is available for students in the first four years of college or other post-secondary education. Up to $2,500 can be claimed for qualified tuition and fees paid per student (credit is claimed on Form 8863).


  1. No felony conviction for possession or distribution of controlled substances;
  2. Program enrollment must work towards a degree, certificate or other recognized credential;
  3. Enrolled in one of the first four years of post-secondary education and
  4. Taking at least half of the normal workload for your program of study.

Phase out for the credit:

  • MAGI range of $90,000 (single filers)
  • MAGI range of $180,000 (married filing jointly)

Lifetime Learning Credit
The lifetime learning credit is available for the taxpayer, spouse and their dependents to cover up to a $2,000 maximum of total qualified education expenses. The credit is not per student, it's only good for one credit per tax return. The credit is calculated on 20% of the first $10,000 of qualified expenses, and up to a maximum of $2,000 (20% x $10,000). This credit can be claimed by filing parts II and IV of Form 8863.

*The same student can only claim either the Lifetime Learning Credit or American Opportunity Credit in the same year.*

  • The American Opportunity Credit is more advantageous, because it can be used for multiple students.

Phase out for the credit:

  • MAGI between $60,000 (single, head of household, widow)
  • MAGI between $120,000 (joint return)

Earned Income Credit
This credit is designed to encourage individuals that are economically disadvantaged to join the workforce. Individuals with or without children, can qualify for the credit depending on the amount of their earned income or family income for the given tax year.

Phase out for the credit:
AGI $7,500 - $13,460 – no children (single, head of household, widow, widower)
AGI $16,450 - $43,352 – with children (single, head of household, widow, widower)
AGI $12,500 - $18,470 – no children (married filing jointly)
AGI $21,500 - $48,632 – with children (married filing jointly)

Accelerated Deductions
Related Articles
  1. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  2. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  3. Professionals

    Career Advice: Financial Planner Vs. Wealth Manager

    Understand the differences between a career in financial planning and wealth management, and identify which is better for you based on your goals and talents.
  4. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  5. Mutual Funds & ETFs

    Mutual Funds Are Not FDIC Insured: Here Is Why

    Find out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
  6. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  7. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  8. Professionals

    The Best Schools for Financial Planning

    Among the best universities for financial planning are the University of Georgia, Boston University, The College of Financial Planning, Texas Tech, San Diego State, Baylor, Fairleigh Dickinson ...
  9. Investing Basics

    Hiring a Financial Advisor? Look for the CFP Label

    Don’t skimp on the CFP designation. Here's why those three letters show that someone is qualified in financial and investment planning.
  10. Mutual Funds & ETFs

    Top 4 Investment Grade Corporate Bonds ETFs

    Discover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
  1. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  2. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  3. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  4. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  5. Gross Exposure

    The absolute level of a fund's investments.
  6. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  1. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  2. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
  3. Do financial advisors work only in banks?

    While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>
  4. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!