Seeking credit

guest commentary by David Potts

Do you know the difference between a tax credit and a tax deduction? Many taxpayers don’t. A tax deduction is an item that is subtracted from your gross or adjusted gross income to arrive at your taxable income. Your taxable income is the starting point to determine how much tax you will pay in a calendar year. Your taxable income determines your tax bracket (currently 10%, 15%, 25%, 28%, 33% or 35%).

The amount of tax savings caused by a deduction is determined by your tax bracket. For example, if your itemized deductions exceed the standard deduction and you are in a 25% tax bracket, an additional $1,000 contribution will lower your tax liability by $250. A tax credit, however, is taken after you compute your income tax liability and it reduces your income tax by one dollar for every dollar of tax credit. If you’re not a CPA or conversant in income tax laws and want to follow this discussion, just remember a dollar of a tax credit is worth a dollar and a dollar of tax deduction is worth anywhere from nothing to 35 cents on the dollar. Take a sip of espresso and let’s continue.

A tax credit can be refundable or non-refundable. If the credit is refundable, the IRS will send you money whether you owe taxes or not. In other words a refundable credit is treated exactly as if you had sent the IRS a tax payment. If you pay too much you get a refund. If the credit is non-refundable the credit will not reduce your taxes below zero. That doesn’t mean you won’t get a refund but you won’t get more than you paid in. Confused? Keep reading. You will still get something out of this discussion.

Qualifying for a tax credit is a good thing because it will reduce your income tax liability. Some of the new credits for 2009 that might affect you when preparing your income tax return are discussed below. The discussion of the credits below is to help you identify tax credits that might be applicable to your income tax return, not provide you with all the requirements you must meet to qualify for the credit. If you think you might qualify, talk with your accountant or read the publications provided by the IRS that provide more information.

• Making Work Pay Credit
New for 2009 and 2010 is the refundable Making Work Pay Credit (MWPC). The credit is the lesser of 6.2% of the taxpayer’s earned income or $400 ($800 on a joint return). The credit is phased out at 2% of your modified adjusted gross income above $75,000 ($150,000 for a joint return). Therefore the credit is completely phased out for those with modified adjusted gross income of $95,000 ($190,000 on a joint return).

Employees receiving W2s have automatically received this credit through the revision of income tax withholding tables employer’s were to use beginning April 1, 2009. The revised withholding tables lowered the amount of income taxes to be withheld during the year in order to help stimulate the economy. Self-employed individuals who qualify for the credit will benefit when they file their income tax returns.

• Nonbusiness Energy Property Credit
Qualified energy efficiency improvements and residential energy property expenditures placed in service at your home in 2009 and 2010 qualify for a credit equal to 30% of the cost up to an aggregate (for both years) of $1,500.

IRS Publication 17 Your Federal Income Tax For Individuals, For Use in Preparing 2009 Returns defines qualified energy efficiency improvements as 1) any insulation material or system that is specifically and primarily designed to reduce heat loss or gain of a home, 2) exterior windows (including skylights), 3) exterior doors, and 4) any metal or asphalt roof that has appropriate pigmented coatings or cooling granules specifically and primarily designed to reduce heat gain of the home that are new, can be expected to remain in use at least five years, and meet certain requirements for energy efficiency.

Residential energy property is any of the following: Certain heat pump water heaters; electric heat pumps; central air conditioners; natural gas, propane, or oil water heaters; stoves that use biomass fuel; qualified natural gas, propane, or oil furnaces; qualified natural gas, propane, or oil hot water boilers; certain advanced main air circulating fans used in natural gas, propane, or oil furnaces.

What’s the easy way to determine if the property qualifies? Ask the manufacturer or distributor if the property qualifies. They will know.

• First-time Homebuyer Credit
The First-time Homebuyer Credit has received a lot of press and we have previously discussed in The City Wire who qualifies for this credit. Just remember, the first-time homebuyer is not always a first time homebuyer and that a long-time resident of the same main home now qualifies.

• American Opportunity Tax Credit
The Hope tax credit has been expanded for 2009 and 2010 and renamed the American Opportunity Tax Credit. The credit is equal to 100% of the first $2,000 of qualified higher-education tuition and related expense and 25% of the next $2,000 for a maximum credit of $2,500 per each eligible student. The credit is available for the first four years of higher education. The credit phases out for taxpayers with modified adjusted gross income of $80,000 to $90,000 ($160,000 to $180,000 for joint filers). Also 40% of the new American Opportunity Tax Credit is refundable. In 2011 the AOTC reverts back to the old Hope tax credit: a lower maximum credit, nonrefundable, available only for the first two years of higher education and phasing out at lower levels of modified adjusted gross income.

The Internal Revenue Code contains many income tax credits you might qualify for to reduce your income tax. Other possible income tax credits which you might benefit include the Adoption Credit, the Alternative Motor Vehicle Credit; the Foreign Tax Credit, the Retirement Savings Contributions Credit, the Health Coverage Credit, the Child and Dependent Care Credit, the Child Tax Credit, the Lifetime Learning Credit, and Electric Vehicle Credits, just to name a few. Check out the available income tax credits.

If you want more information on tax credits and how they might save you money by reducing your taxes talk with a CPA or read chapter 37 in IRS Publication 17 Your Federal Income Tax For Individuals, For Use in Preparing 2009 Returns.

David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow more of his thoughts at ThePottsReport.com. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.

Also, feel free to e-mail topic suggestions or questions to [email protected]