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Individual
Tax Credits

Master the rules for nonrefundable and refundable credits that directly reduce a taxpayer's liability: from the Child Tax Credit to the Earned Income Credit.

CPA Regulation (REG)

What Is a Tax Credit?

A tax credit is a dollar-for-dollar reduction of the tax you owe. Unlike a deduction, which only reduces taxable income, a credit reduces your actual tax liability directly.

Credits vs. Deductions

DEDUCTION
Gross Income: \( \$80{,}000 \)
\( - \$10{,}000 \) Deduction
Taxable Income: \( \$70{,}000 \)
At 22% bracket:
Saves \( \$2{,}200 \)
CREDIT
Tax Liability: \( \$15{,}400 \)
\( - \$2{,}000 \) Credit
Tax Owed: \( \$13{,}400 \)
Regardless of bracket:
Saves \( \$2{,}000 \)
vs.

Two Types: Refundable vs. Nonrefundable

Refundable Credits
Can reduce tax below \( \$0 \): the excess is refunded to the taxpayer. Example: Earned Income Credit (EIC).
Nonrefundable Credits
Can only reduce tax to \( \$0 \): no refund of the excess. Example: Child and Dependent Care Credit.

The Credit Ordering Rule

1. Compute Tax Liability
2. Apply Nonrefundable Credits
3. Floor at \( \$0 \) (no negative)
4. Apply Refundable Credits
= Tax Owed (or Refund)

Major Individual Tax Credits

Child Tax Credit
Up to \( \$2{,}000 \) per qualifying child. Partially refundable (up to \( \$1{,}600 \) as Additional CTC).
Child/Dependent Care
20%-35% of up to \( \$3{,}000 \) for one dependent or \( \$6{,}000 \) for two or more. Nonrefundable.
Education Credits
AOTC: up to \( \$2{,}500 \) (40% refundable). LLC: up to \( \$2{,}000 \) (nonrefundable).

More Key Credits to Know

Earned Income Credit
Fully refundable. Phases in and out based on earned income. Max ~\( \$7{,}430 \) with 3+ children.
Adoption Credit
Up to \( \$15{,}950 \) per child. Nonrefundable but can carry forward 5 years.
Saver's Credit
10%-50% of up to \( \$2{,}000 \) contributed to retirement plans. Nonrefundable. For lower-income taxpayers.

Child Tax Credit: Phase-Out

The \( \$2{,}000 \) Child Tax Credit phases out by \( \$50 \) for every \( \$1{,}000 \) (or fraction) of modified AGI exceeding the threshold.

1
Threshold: \( \$200{,}000 \) (single) or \( \$400{,}000 \) (married filing jointly).
2
Phase-out rate: \( \$50 \) reduction per \( \$1{,}000 \) excess AGI.
3
Refundable portion: Up to \( \$1{,}600 \) as the Additional Child Tax Credit (ACTC).

AOTC vs. LLC

AOTC Lifetime Learning
Max Credit \( \$2{,}500 \) \( \$2{,}000 \)
Refundable? 40% (\( \$1{,}000 \)) No
Years Available First 4 years Unlimited
Course Load At least half-time Any (even 1 course)
Felony Drug? Disqualified No restriction
Per Student? Yes Per return

Earned Income Credit: Phase-In/Phase-Out

Earned Income Credit Amount Phase-in Maximum Credit Phase-out

How to Apply Credits Step by Step

1
Compute regular tax liability from taxable income using the tax rate schedule.
2
List all nonrefundable credits: Child/Dependent Care, LLC, Saver's, Adoption, Elderly/Disabled, etc.
3
Subtract nonrefundable credits from tax liability. Floor at \( \$0 \): excess nonrefundable credits are lost (unless carryforward applies).
4
List all refundable credits: EIC, 40% of AOTC, Additional Child Tax Credit.
5
Subtract refundable credits. If the result is negative, the taxpayer receives a refund.

Example 1: Basic Credit Application

A single taxpayer has a tax liability of \( \$8{,}500 \). She qualifies for a Child and Dependent Care Credit of \( \$1{,}200 \) (nonrefundable) and an EIC of \( \$3{,}400 \) (refundable).

1
Tax liability: \( \$8{,}500 \)
2
Subtract nonrefundable: \( \$8{,}500 - \$1{,}200 = \) \( \$7{,}300 \)
3
Subtract refundable: \( \$7{,}300 - \$3{,}400 = \) \( \$3{,}900 \)

Example 2: Nonrefundable Excess Lost

A taxpayer has a tax liability of \( \$800 \) and qualifies for the Lifetime Learning Credit of \( \$2{,}000 \) (nonrefundable) and no refundable credits.

1
Tax liability: \( \$800 \)
2
Subtract LLC: \( \$800 - \$2{,}000 = -\$1{,}200 \) → Floor at \( \$0 \)
3
Excess \( \$1{,}200 \) is lost: the LLC has no carryforward.

Example 3: CTC Phase-Out Calculation

A married couple filing jointly has 2 qualifying children and modified AGI of \( \$425{,}000 \). What is their Child Tax Credit?

1
Base credit: \( 2 \times \$2{,}000 = \$4{,}000 \)
2
Excess AGI: \( \$425{,}000 - \$400{,}000 = \$25{,}000 \)
3
Reduction: \( \$50 \times (\$25{,}000 \div \$1{,}000) = \$50 \times 25 = \$1{,}250 \)
4
Allowed CTC: \( \$4{,}000 - \$1{,}250 = \) \( \$2{,}750 \)

Common Mistakes

✕ Confusing Credits with Deductions
A credit reduces tax liability dollar-for-dollar. A deduction only reduces taxable income. Don't mix them up on the exam.
✕ Refunding a Nonrefundable Credit
Nonrefundable credits can only reduce tax to \( \$0 \). The excess is lost (unless carryforward exists, e.g., Adoption Credit).
✕ Applying AOTC and LLC to Same Student
You cannot claim both the AOTC and LLC for the same student in the same year. Choose the more beneficial one.

Credits Summary Table

Credit Max Amount Refundable? Carryforward?
Child Tax Credit \( \$2{,}000 \) Partially No
Child/Dependent Care \( \$1{,}050 \) / \( \$2{,}100 \) No No
AOTC \( \$2{,}500 \) 40% No
LLC \( \$2{,}000 \) No No
EIC ~\( \$7{,}430 \) Yes N/A
Adoption \( \$15{,}950 \) No 5 years
Saver's Credit \( \$1{,}000 \) No No

Question 1 of 5

A taxpayer has a tax liability of \( \$3{,}000 \) and a nonrefundable credit of \( \$4{,}500 \). What is the tax owed after applying the credit?

Question 2 of 5

Which of the following credits is fully refundable?

Question 3 of 5

A single taxpayer with one qualifying child has AGI of \( \$215{,}000 \). What is the allowed Child Tax Credit?

Question 4 of 5

A student in her fifth year of college takes two courses. Which education credit may she claim?

Question 5 of 5

A taxpayer has a tax liability of \( \$1{,}800 \), an AOTC of \( \$2{,}500 \), and no other credits. What is the net tax owed or refund?