What’s the difference?
The two most popular ways to reduce your tax burden are tax credits and tax deductions. While they sound similar, the two are very different. A tax credit gives you a dollar-for-dollar reduction of the tax you owe, while a tax deduction lowers your taxable income.
Dollar-for-dollar, tax credits reduce the amount of tax you owe. There are different kinds of tax credits and whether you qualify for a particular one depends on several factors, including your income, tax filing status and your age.
Nonrefundable tax credit
If the credit reduces your tax liability to a negative number, such as receiving a $1,500 tax credit when you owe $1,400 in taxes, the extra money cannot be used.
Refundable tax credit
Refundable tax credits can actually increase your tax refund. An example of a refundable tax credit is the Earned Income Tax Credit. Credits such as the American Opportunity Tax Credit are partially refundable.
Common tax credits include:
- Child and Dependent Care Credit
- Adoption Credit
- Child Tax Credit
- Premium Tax Credit (for those who purchased health insurance through the federal marketplace)
- Saver’s Credit (for people who contributed to a tax-advantaged retirement account)
- Lifetime Learning Credit (for higher education expenses)
Tax deductions, on the other hand, reduce your taxable income. There are two ways to claim tax deductions: the standard deduction and itemizing your deductions. You can do one or the other, but not both.
The standard deduction
The standard deduction is a one-size-fits-all reduction in the amount of your income that is subject to tax. It is an automatic deduction that you won’t need to do anything to qualify for.
How much you can deduct depends on your filing status. The largest standard deduction is for married couples filing jointly on a tax return.
|Filing status||2021 tax year||2022 tax year|
|Married, filing jointly||$25,100||$25,900|
|Married, filing separately||$12,550||$12,950|
|Head of household||$18,800||$19,400|
You can itemize your deductions by listing out individual expenses that you wish to write off on your tax return. These expenses include home mortgage interest, medical expenses, or charitable donations. This method makes the most sense if your deductible expenses are higher than the standard deduction available to you. You’ll need to use the regular Form 1040 and Schedule A.
Work-related deductions include:
- Business expenses
- Business use of a car
- Business use of a home
Education deductions include:
- Work-related educational expenses (for education that is improving skills in your present work or by law is required to keep your job/salary)
- Teachers’ educational expenses – eligible educators can deduct up to $250 for unreimbursed expenses for classroom materials
- Student loan interest
Health care deductions include:
- Medical and dental expenses
- Health Savings Account (HSA)
Investment related deductions include:
- Sale of a home
- Capital losses
- Bad debt
- Opportunity zones
I want to know more about US taxes abroad
Figure out which credits and deductions you can take
As a US citizen living abroad, let your tax professional do this for you. Your options to claim are different to those living in the United States.
If you’re interested, here are some general common credits and deductions;
Foreign Earned Income Exclusion (FEIE): this is the big one for US citizens and Green Card holders living abroad. If you’re living in a country where the income tax rates are lower than they are in the US, the FEIE might just become your best friend.
The Foreign Earned Income Exclusion allows you to exclude over US$100,000 of income from your “taxable income”.
The Exclusion amount goes up each year. For tax year 2021 the total FEIE is US$108,700.
For tax year 2022, the total is increased to $112,000.
Foreign Housing Exclusion: the next best thing for US expats is the Foreign Housing Exclusion. With this exclusion, you can deduct significant living expenses from your income before you’re taxed. The FHE can cover expenses such as rent, utilities, internet, residential parking and renting furniture.
You can learn about the Foreign Housing Income here:
Saver’s credit: if you are neither a full-time student nor being claimed as a dependent on someone else’s tax return, you could be eligible for a tax credit if you contribute to a retirement plan. The amount of saver’s credit you could receive is dependent on your filing status and AGI (adjusted gross income). For the tax year 2021, as a single filer with an AGI of $33,000 or less, or if you are married filing jointly with an AGI of $66,000 or less, you may be eligible.
Student loan interest: dependent on your AGI, you may be able to deduct up to $2,500 in interest payments.
Freelance expenses: if you are self-employed working freelance, you may be able to claim deductions for work-related expenses including office supplies or industry subscriptions.
Charitable deductions: if you itemize your taxes, you should be able to deduct charitable donations.
What is the Child Tax Credit?
The Child Tax Credit (CTC) is claimed to reduce tax liability by receiving a credit per qualifying child. This credit is phased out, as well as being refundable. Families can receive a refund where the credit exceeds taxes owed.
Note: you cannot claim the Child Tax Credit if you claim the Foreign Earned Income Exclusion.
In order to be eligible for the Child Tax Credit, the following criteria must be met:
- The child is 16 years old or younger at the end of the tax year
- The child is a US citizen with a valid SSN (Social Security Number)
- You also need to claim the child as a dependent on your return and the child must have lived with you for more than half of the tax year.
From 2022-2025, the Child Tax Credit will revert back to what it was before changes were introduced through new law in 2021, as established by the 2017 TCJA.
The new credit available from 2022 will be up to $2,000 for each child under the age of 17. This credit will decrease by 5% of AGI over $200,000 for single parents, or $400,000 for married couples.
Will the Child Tax Credit remain refundable in 2022?
This credit will only be partially refundable. If the credit awarded exceeds taxes owed the tax refund will be capped at $1,400.
This $1,400 is referred to as the Additional Child Tax Credit (ACTC), or ‘refundable CTC’. However, the ACTC is limited to 15% of earnings over $2,500 – this means that those with very low income can only claim a reduced credit or will not be able to claim the credit at all.
What is a Refundable Tax Credit?
You can receive a refund greater than the amount of tax you have paid. It can create a negative federal tax liability, where if your US tax liability is already zero, a refund payment can be claimed.
What is the American Opportunity Credit?
The American Opportunity credit is aimed at taxing college students or their parents, to reduce the costs of education. This credit can offer greater tax savings compared to other education related tax benefits. The American Opportunity credit reduces your taxes on a dollar-for-dollar basis, rather than just reducing your income tax liability.
There are several requirements to be eligible to receive the American Opportunity credit.
To be a student that is eligible for the American Opportunity credit, you must meet the following criteria:
- Be enrolled in at least one academic semester during the applicable tax year;
- Maintain at least half-time status in a program that leads to a degree or credential;
- Have not completed the first four years of post-secondary education;
Why am I not eligible for the American Opportunity credit?
You are not eligible for the American Opportunity credit if:
- You have completed the first four years of post-secondary education
- Have less than half-time status in a degree program.
- Have been convicted of a state or federal crime because of a drug conviction.
How many times can I claim the American Opportunity Tax Credit?
As an eligible student, you can receive a maximum of one American Opportunity tax credit each year. If you are a parent claiming the American Opportunity credit for your dependent students, and have two eligible dependents, you can claim different educational tax benefits for them. You just can’t claim more than one tax benefit per year for each student.
How to calculate your American Opportunity Tax Credit:
The amount of credit available is equal to:
- 100% of the first $2,000 of qualified expenses, plus:
- 25% of the expenses that are in excess of $2,000.
The maximum annual American Opportunity credit available per student is $2,500.
Can I claim the American Opportunity Tax Credit if I get financial aid?
For the American Opportunity credit, the IRS does not require a reduction of qualified expenses by any amount paid with borrowed funds, such as student loans or credit cards. However, you cannot include any amounts received from the following:
Tuition grants from an employer;
- Tax-free scholarships or fellowships;
- School refunds;
- Federal Pell grants;
- Non-taxable assistance other than gifts and inheritances.
What expenses qualify for the American Opportunity tax credit?
The American Opportunity credit does not cover costs associated with the following:
- Medical insurance
Given that the purchased items you are claiming relate to the program of your study, expenses that qualify for the American Opportunity credit include the costs of:
- Equipment for your studies
These can be claimed as long as you are paying tuition fees to an eligible educational institution.
How do I know if I claimed the American Opportunity credit?
To claim for the American Opportunity tax credit, either the student or the taxpayer claiming the student as their dependent, must complete the relevant sections of IRS Form 8863 and attach it to their personal income tax return.
Why do I only get $1000 for the American Opportunity credit?
The American Opportunity credit begins to phase out when:
– Single taxpayers have an AGI (adjusted gross income) that is between $80,000 and $90,000
– Taxpayers filing jointly have an AGI that is between $160,000 and $180,000
The tax credit becomes completely unavailable to taxpayers whose AGI exceeds these thresholds ($90,000 for single filers or $180,000 for joint filers).