In this episode we’ll discuss tax credits and we’re going to speak with Stephen Fishman, author of Lower Taxes in Seven Easy Steps (Nolo) In a previous episode, we talked to Steve about tax deductions.
Many people are confused as to the difference between a credit and a deduction.
Here’s how it works. Let’s say you’re in the 28% tax category. If you had a $1,000 tax deduction, you would deduct that from your taxable income and then you determine your taxes. The result of deducting $1,000 is that you would save $280 in taxes. But if you had a $1,000 tax credit, you could deduct that directly from your taxes. So you would save $1,000 in taxes. So, a $1000 tax credit is always going to be more valuable –maybe three or four times as valuable – as a $1000 tax deduction. It all depends on your tax rate.
Nolo: Okay, we asked Steve Fishman what could a typical family do to maximize their tax credits? What’s available to your average tax paying family member?
Stephen Fishman: Well, if they had a baby, bought a hybrid car, added new insulation to their home, installed a solar water heater in their home, incurred child care expenses so that they could both work, and took night classes at a local college they could have reduced their taxes by approximately $6,000 to $7,000.
Nolo: It’s been reported that the average tax credit for a hybrid car is $2,000. We asked Steve if that was accurate
Stephen Fishman: Not necessarily $2,000. That depends on the type of car and its fuel consumption statistics., In addition, another factor complicates things. Congress didn’t want to allow too many tax credits for hybrids, so once a hybrid manufacturer sells 60,000 vehicles, the credit will be phased out over the following 15 months for all hybrids produced by that company. You can find the phase-out times and percentages in my book, and at the IRS website.
Nolo: That brings up another point, tax credits come and go. Some tax credits have been around for years and are more or less permanent—for example, the child care credit and low income housing credit, for example. Others have been created more recently and have scheduled phase-out dates. Congress can, and often does, extend credits that are scheduled to end. Some credits like the research and experimentation, work opportunity, and welfare to work credits have been extended one year at a time for several years. However, there is no guarantee that Congress will extend a tax credit so it’s always wise to act before the expiration date if you want to use a tax credit that is scheduled to expire.
As Steve pointed out there are various tax credits for homeowners and as he indicates in his book, fuel efficiency is the primary target, here. Among the credits, there are great breaks for homeowners who put in fuel efficient windows, roofing, insulation, and heating and cooling systems.
However, there are some rules you’ll have to follow: Homeowners must buy these energy efficient products during 2006 and 2007 and the total combined credit you can get for all tax years is $500, and no more than $200 of the credit can be for windows. The other thing to keep in mind is you get the credit only if the items you buy meet the energy efficiency specifications established by law and a lot of these specifications are quite stringent—for example, an electric heat pump water heater qualifies for the credit only if its energy efficiency is over twice as great as the current federal standard. Make sure the product you want to buy qualifies—don’t take a salesperson’s word for it. Also, more generous credits are available to homeowners who install solar water-heating or electric power systems in their homes.
Steve Fishman also mentioned that there is a tax credit for having a child. That child tax credit was created for low and middle income taxpayers. We asked Steve about the requirements.
Stephen Fishman: It is subject to an income threshold and the amount of credit you can take each year goes down as your income approaches that threshold amount. For example, a married couple filing jointly with one qualifying child gets no child tax credit if their adjusted gross income exceeds $130,000.
Nolo: We asked Steve Fishman what about tax credits for couples who adopt children?
Stephen Fishman: Yes, there is a tax credit for people who adopt children. The credit is equal to 100% of adoption expenses up to an annual ceiling. The ceiling was $10,960 per child in 2006.
Nolo: As Steve mentioned, there are educational tax credits, as well. Congress figures that well-educated taxpayers will make more money and be able to pay more taxes so it has created two tax credits for expenses related to higher education: the Hope tax credit, and the lifetime learning credit. There are a lot of rules and restrictions for both. As a general rule, if the total expenses involved are $7,500 or less, Steve suggests in his book that it’s usually better to use the Hope credit if you have a choice. If your expenses are above that amount, Steve suggests in his book that it’s better to use the lifetime learning credit because the lifetime learning credit is larger for expenses over the threshold amount. Also, keep in mind that a parent can only claim the Hope tax credit for their child during the first two years at college.
As for retirement tax credits, there is one designed to benefit people with modest incomes who save for their retirement. There are a lot of restrictions, but the main one to keep in mind is that your adjusted gross income is not more than $50,000 if your filing status is married filing jointly, or $25,000 if your filing status is single.
What about tax credits for businesses? We haven’t touched on those yet? We asked Steve Fishman what are some of the choices for a small business owner.
Stephen Fishman: Right, if you have a business there are few types of activities that Congress views favorably enough to warrant a tax credit. These categories include:
• helping the disadvantaged or disabled
• improving the environment
• helping your employees, or
• investing in research and development.
You may be able to qualify for several different credits at the same time. However, there is an overall limit on total business credits you can take in a year which is based on your tax liability. If you exceed the limit, you can take the credits in future years or apply them to previous years’ taxes—within limits.
Nolo: As Steve reports in his book, one credit most businesses may be able to use is the solar power credit. Businesses can get a credit up to 30% of the cost of buying and installing solar equipment to generate electricity to heat or cool a structure, or to provide solar process heat. Unlike the solar credit for homeowners, there is no dollar limit on this business credit. We asked Steve about some of the business credits a business can get by helping employees?
Steve Fishman: There are a couple of credits you can get if you do some nice things for your employees. One is the credit for employer-provided childcare. This credit is limited to $150,000 each year. The other is a credit for small employer pension startup costs. If you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension, you can receive a tax credit of 50% of the first $1,000 of qualified startup costs.
It’s probably hard for most listeners to remember all these details. Tax information is not the most riveting subject matter. So we recommend Steve’s book for more details, Lower Taxes in Seven Easy Steps. And on the the IRS is the best place to keep up on tax credits, that’s www.irs.gov.
