Tax credit
A tax credit is a tax incentive which allows certain taxpayers to subtract the amount of the credit they have accrued from the total they owe the It may also be a credit granted in recognition of taxes already paid or, as in the United Kingdom, a form of state support for low earners.
Incentive tax credits may be used to encourage behaviors like investment or parenting. A credit directly reduces tax bills, unlike tax deductions and tax exemptions, which indirectly reduce tax bills by reducing the size of the base (for example, a taxpayer's income or property value) from which the tax bill is calculated.
Most tax credits are nonrefundable tax credits and so do not apply if no taxes are owed. However, some tax credits are refundable tax credits so if the credit exceeds the amount of taxes owed, the excess is returned to the taxpayer.
Income tax systems often grant a variety of credits to individuals. These typically include credits available to all taxpayers as well as tax credits unique to individuals. Some credits may be offered for a single year only.
Several income tax systems provide income subsidies to lower income individuals by way of credit. These credits may be based on income, family status, work status, or other factors. Often such credits are refundable when total credits exceed tax liability.
In the United Kingdom, the Child Tax Credit and Working Tax Credit are paid directly into the claimant's bank account or Post Office Card Account. In exceptional circumstances, these can be paid by cash cheque (sometimes called ) however payments may stop if account details are not provided.A minimum level of Child Tax Credits is payable to all individuals or couples with children, up to a certain income limit. The actual amount of Child Tax Credits that a person may receive depends on these factors: the level of their income, the number of children they have, whether the children are receiving Disability Living Allowance and the education status of any children over 16.
Working Tax Credit is paid to single low earners with or without children who are aged 25 or over and are working over 30 hours per week and also to couples without children, at least one of whom is over 25, provided that at least one of them is working for 30 hours a week. If the claimant has children they may claim Working Tax Credit from age 16 upward provided that they are working at least sixteen hours per week.
Tax Credits are capped which many sources claim affects the poorest families disproportionately. A survey by End Child Poverty estimated that roughly 1.5 million parents have reduced spending on basics like food and fuel. According to Gavin Kelly of the Resolution Foundation, tax credits help raise living standards of low paid workers. He wrote in the New Statesman, "Perhaps the biggest misconception is the voguish notion that if tax credits are cut, employers will somehow decide to offer pay rises to fill the gap. This is saloon-bar economics espoused by some on both left and right."
On 15 September 2015, the House of Commons voted to decrease Tax Credit thresholds, a law that came into effect on 6 April 2016. Opponents claimed that it would harm those on low incomes. Simon Hopkins, Chief Executive of charity commented "Today's vote in the House of Commons will mean one thing for many of the poorest working families in the UK; they are going to get poorer. Tax credits are a vital source of income for those on a low wage and for many they make up a substantial portion of their monthly income.
The IFS supported the opposition view that the effects of the changes would disproportionately reduce the income of poor families, even taking into account reductions in income tax and an increase in the National Living Wage. The government responded that the tax credit system had, for too long, been used to subsidies low pay and the changes would bring total expenditure on tax credits back down to more sustainable levels seen in 2007–08.
On 26 October 2015 the House of Lords supported a motion from Baroness Meacher delaying the imposition of the cuts until a new consideration of the effects could be made by the House of Commons.
The U.S. system grants the following low income tax credits:
- Earned income credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2013, the maximum credit was $6,044 for taxpayers with three or more qualifying children.
- Credit for the elderly and disabled: a nonrefundable credit up to $1,125.
- Retirement savings contribution credit: a nonrefundable credit of up to 50% for up to $2000 of contributions to qualified retirement savings plans, such as IRAs (including the Roth, SEP and IRA), 401(k)/403(b)/457 plans and the Thrift Savings Plan; phased out starting (for the 2014 tax year) at incomes above $18,000 for single returns, $27,000 for heads of household, and $36,000 for joint returns.
- Mortgage interest credit: a nonrefundable credit that may be limited to $2,000, granted under specific mortgage programs.
- Premium tax credit: this refundable credit is provided to individuals and families who obtain healthcare insurance policies through a healthcare exchange, and whose income falls between 100% and 400% of the applicable federal poverty line. It was first introduced in the 2014 tax year.
Some systems grant tax credits for families with children. These credits may be on a per child basis or as a credit for child care expenses.
The U.S. system offers the following nonrefundable family related income tax credits (in addition to a tax deduction for each dependent child):
- Child credit: Parents of children who are under age 17 at the end of the tax year may qualify for a credit up to $1,000 per qualifying child. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.
- Child and dependent care credit: If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim a credit up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.
- Credit for adoption expenses: a credit up to $10,000, phased out at higher incomes. Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.
- Family tax credit is a payment for each dependent child aged 18 or young
Some systems indirectly subsidize education and similar expenses through tax credits.
The U.S. system has the following nonrefundable credits:
- Two mutually exclusive credits for qualified tuition and related expenses. The American Opportunity Tax Credit is 100% of the first $2,000 and 25% of the next $4000 of qualified tuition expenses per year for up to two years. The Lifetime Learning Credit is 20% of the first $10,000 of cumulative expenses. These credits are phased out at incomes above $50,000 ($100,000 for joint returns) in 2009. Expenses for which a credit is claimed are not eligible for tax deduction.
- First time home buyers credit up to $7,500 (closing date before Sept. 30, 2010).
- Credits for purchase of certain non business energy property and residential energy efficiency. Several credits apply with differing rules.
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