Tax credits are better than deductions. A tax deduction will reduce your taxable income, but a credit will directly increase your refund. For example, in the 10 percent tax bracket a $1,000 tax deduction will reduce your income by $1,000 thus saving you $100 in taxes. But a $1,000 tax credit will reduce your taxes by $1,000. Plus, even if you owe no taxes you will still get a $1,000 refund.
What are the best tax credits? That depends on your situation. But let's look at some of the ones with the highest potential.
Alternative Energy Tax Credits
The alternative energy tax credit for installation of alternative energy projects, like solar or wind, qualifies you for a 30 percent credit based on the total cost of your energy installation. There is no limit on the amount of credit, so theoretically if you spent $100,000 on a wind farm in your backyard you could get a $30,000 credit. You can also get a credit for making your home more energy efficient. It also is limited to 30 percent of actual costs, but has a maximum credit of $1,500.
Adoption Tax Credit
If you adopted a child, you may be eligible for the adoption tax credit that is not limited to a percentage of your expenses. It will cover all of your actual expenses up to $10,000. In addition to the credit, you may also qualify for a deduction for expenses related to adoption paid by your employer.
New Home Buyer Credit
Home purchases contracted before April 30, 2010, and settled before June 30, 2010, may be eligible for up to 10 percent of the purchase price up to $6,500. This credit was originally only for new-home buyers, but was extended to all home buyers of a new principal residence. For first-time buyers the credit is up to $8,000.
Earned Income Credit
The earned income credit is for wage earners with qualifying dependents who earn less than $48,279. Other restrictions require a maximum of $3,100 in investment income. This credit increases based on the number of qualifying children with a maximum of $5,657 for three children.
American Opportunity Credit
This tax credit is designed to help parents and students afford college. It allows a credit for education expenses and has been expanded to cover required course materials. The maximum annual credit is $2,500 per student.
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