Lesson 12: Tax Credits Overview

Welcome to Lesson 12 of our instructable on Exploring Federal Income Tax Law. In this lesson, we will explore the concept of tax credits, which form a significant part of the larger topic of Deductions and Credits.

What Are Tax Credits?

Tax credits are amounts of money that taxpayers can subtract directly from the taxes they owe. Unlike deductions, which reduce the amount of income that is subject to tax, tax credits reduce the actual tax liability. Tax credits can be more advantageous than deductions because they directly reduce the tax owed.

Types of Tax Credits

Nonrefundable Tax Credits: These credits can reduce your tax liability to zero but cannot result in a refund.
Refundable Tax Credits: These credits can reduce your tax liability below zero, resulting in a refund.
Partially Refundable Tax Credits: These credits have both refundable and nonrefundable components.

Tip: It is crucial to understand the different types of tax credits to maximize your tax savings. Keep this in mind as you plan your finances!

Common Tax Credits

Some of the most common tax credits include:

Visualizing Tax Credits

Below is a diagram to help visualize how nonrefundable and refundable tax credits work:

graph TD A["Gross Income"] --> B["Adjusted Gross Income (AGI)"] B --> C["Taxable Income"] C --> D["Gross Tax Liability"] D --> E["Apply Nonrefundable Credits"] E --> F["Net Tax Liability"] F --> G["Apply Refundable Credits"] G --> H["Final Tax"]

Example Calculation

Let's consider an example where a taxpayer has a tax liability of $3,000 before credits. They qualify for a nonrefundable credit of $1,000 and a refundable credit of $500.

  const grossTaxLiability = 3000;
const nonrefundableCredit = 1000;
const refundableCredit = 500;

const netTaxLiability = grossTaxLiability - nonrefundableCredit;
const finalTax = netTaxLiability - refundableCredit;

console.log('Net Tax Liability: $' + netTaxLiability);
console.log('Final Tax: $' + finalTax);

Output: