Tax planning involves using all the deductions and credits you are entitled to in a given tax year. Deductions take away your income, reducing it by paying taxes on less earnings. The credits are deducted from the tax you owe. This makes loans more favorable than deductions. Here’s how it works.
What is a tax credit?
The Internal Revenue Service offers more tax credits. You can claim credits for foreign taxes, childcare expenses, tuition and school fees, as well as adoption costs.
You may also be eligible for loans based on your age or disability if you have contributed to a retirement savings account and have small children living with you.
What is a tax liability?
A tax credit is a reduction in your dollar-for-dollar gross tax liability, the total amount of tax you are responsible for paying before all credits apply. You can find your gross tax liability on line 47 of Form 1040 of 2016. on line 30 of Form 1040A and line 10 of Form 1040EZ.
Taxes withheld from your salary during the year represent an advance on your gross tax liability. You get a refund for any amount in excess of what you really owe if too much is kept from your paycheck.
Refundable Vs. Nonrefundable Credits
Tax credits reduce your gross tax liability, but not necessarily below zero. If you qualify for several credits, some of them may be lost after your tax account is cleared because most of the credits are non-refundable.
For example, if your tax liability is $ 5,000 and you are entitled to $ 7,000 in non-repayable loans, you won’t owe anything to the IRS because your $ 5,000 debt is cleared for loans, but the IRS will keep the balance of $ 2,000.
Control this on payday loans. If you have more refundable loans than you have tax liability, you will receive a refund for the amount.
An infected income tax and an additional child tax credit are two examples of payday loans. Tax refunds include additional income tax withheld from your paycheck, as well as any excess tax credit that did not go toward erasing your tax debt. You will get more money from the IRS than you actually paid.
Carryover tax credits
Several loans can be carried over from year to year so you do not lose the excess even if they cannot be repaid. Sometimes they can go back to previous tax years. Foreign tax credit, adoption tax credit and home energy loan allow for transfer from 2016.
Your net tax liability – as opposed to your gross tax liability – is the tax that you are responsible for paying after applying the tax credits you are entitled to. Your net tax liability is on a line called “total tax” on your tax form. That’s line 63 on 2016 Form 2016, line 39 on Form 1040A and line 12 on Form 1040EZ. Most credits apply to this cheek and are reduced to Formulas 1040 and 1040A. The credits apply before line 12 on 1040EZ.
NOTE: Tax laws and forms change periodically. The information above may not reflect the most recent changes. Please consult with a tax professional for the latest tips. The information contained in this article is not intended for tax advice and is not a substitute for tax advice.