The Better Way to Cut Your IRS Bill

When it comes to taxes, credits are the preferred way to cut your bill.

While deductions, either itemized or standard, reduce your amount of taxable income, credits cut your actual tax bill, dollar-for-dollar. That's because credits come into play AFTER your tax liability is figured. So if you owe Uncle Sam $500, a $250 tax credit will cut your bill in half.

Two types of tax credits
Similarly, some credits are more valuable than others.

Refundable credits may eliminate any tax you owe and provide you with a refund. Even if your tax bill is zero, you could get money back from the Internal Revenue Service. These credits include:

• Earned income tax credit
• Additional child tax credit
• Credit for taxes withheld on wages and other amounts

Nonrefundable credits can take your tax down to nothing, but you can't get money back from the government. Popular nonrefundable credits are:

• Child tax credit
• Child and dependent care credit
• Credit for the elderly or disabled
• Retirement savings contributions credit
• Adoption expenses credit
• HOPE and Lifetime Learning education credits

While these credits can't be used to get a refund on your tax return, the unused amount can be carried over from year to year until the credit is absorbed, or the carry-forward period expires, whichever is first.

Tax law changes enacted in 2001 also make the child tax credit partially refundable for lower-income families.

When claiming credits on your federal income tax return, only the earned income credit can be taken by Form 1040EZ filers. To get the benefit of the other credits, you must use Form 1040 or Form 1040A, and some of these credits require you to fill out additional forms.

Article from Bankrate.com