Tax Credit
A direct reduction of tax liability offering dollar-for-dollar tax savings, providing greater benefit than deductions and often used to incentivize specific behaviors.
Tax Credit
A direct reduction of tax liability that provides dollar-for-dollar tax savings, offering greater benefit than tax deductions and often used to incentivize specific behaviors or activities deemed socially or economically beneficial.
For example, a business investing $100,000 in qualifying solar energy equipment might claim a 30% investment tax credit of $30,000, directly reducing its tax bill by that amount rather than merely reducing its taxable income.
Tax credits offer more valuable benefits than deductions of equal amount, as deductions only reduce taxable income at the taxpayer’s marginal rate. Credits fall into several categories: refundable credits (like the Earned Income Tax Credit) can generate refunds beyond tax liability; nonrefundable credits (like Child Tax Credit) can eliminate tax but not generate refunds; and carryforward credits (like General Business Credit) allow unused amounts to offset future years’ taxes. Common business credits include research and development, work opportunity, renewable energy, and rehabilitation credits, while individuals may benefit from child care, education, homebuyer, and energy efficiency credits, each with specific eligibility requirements and documentation needs.