What are tax credits and how do they work?

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Credits directly reduce the tax you owe.

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Tax credits can be among the most valuable tax breaks because they directly reduce your tax bill. If you qualify for a $1,000 tax credit, for example, you can generally subtract up to $1,000 from the federal income tax you owe.

Some tax credits are refundable, while others are nonrefundable. The distinction determines whether a credit can do more than simply reduce your tax bill to zero.

Refundable credits. These credits can result in a refund even if you don’t owe any tax for the year, but you must file a tax return to claim them.

Nonrefundable credits. These credits can only reduce your tax bill to zero—they don’t result in a refund if you owe no federal taxes. For example, if you qualify for a $2,000 credit but owe only $1,000, you can use $1,000 of the credit. The unused portion of some nonrefundable credits can be applied, or carried forward, to future years’ taxes.

Raising a family can be fiendishly expensive. Several federal tax credits can help offset some of the costs of raising children or caring for other dependents.

The child tax credit (CTC) is worth up to $2,200 for each qualifying child under age 17. You can receive the full credit if your annual adjusted gross income (AGI) is no more than $200,000, or $400,000 if married filing jointly; the credit begins to phase out above those amounts. The CTC is nonrefundable, but taxpayers with little or no federal income tax liability may qualify for the additional child tax credit (ACTC), a refundable portion worth up to $1,700 for each qualifying child.

If you paid expenses for the care of someone who depends on you—such as a child or an adult with disabilities—so you (and your spouse, if filing jointly) could work or look for work, you may be able to claim the child and dependent care credit. A qualifying person can be a child under age 13, or your spouse or another dependent who was physically or mentally incapable of self-care.

The credit is calculated on up to $3,000 of qualifying care expenses for one person, or $6,000 for two or more. The percentage of expenses you can claim ranges from 20% to 35%, depending on your AGI. Once your AGI exceeds $43,000, the credit equals 20% of eligible expenses. For example, if your AGI is $100,000 and you paid $6,000 in day care expenses for your three-year-old child, your credit would be $600 (20% of the $3,000 expense limit). The credit is nonrefundable.

You may be eligible for the earned income tax credit (EITC) if your income is low to moderate; the amount depends on your income, filing status, and number of qualifying children. There are special rules for military, clergy, and taxpayers with disabilities. The EITC is a refundable tax credit.

Qualified expenses such as adoption fees, court costs, and travel expenses are eligible for a tax credit. The maximum credit for each adopted child is $17,280 for 2025 and $17,670 for 2026. This credit is refundable up to $5,000 for 2025 and $5,120 for 2026. Any unused nonrefundable portion can be carried forward for up to five years. Adopting your spouse’s child doesn’t qualify for the adoption credit. Income limits also apply:

College can be expensive, too. Two federal tax credits can help offset the cost of higher education.

This credit is for qualified education expenses paid for an eligible student during the first four years of higher education. The maximum annual credit is $2,500 per student (calculated as 100% of the first $2,000 of qualified education expenses plus 25% of the next $2,000 in expenses). For example, if your son went to community college and you paid $3,000 for tuition, you would get a $2,250 credit: $2,000 plus 25% of the next $1,000. You need at least $4,000 in expenses to qualify for the full $2,500 credit.

Beginning in 2026, new Social Security number requirements apply to education credits. You, your spouse if filing jointly, and the student, if your dependent, generally must have Social Security numbers valid for work by the tax return due date, including extensions.

If you have 529 college savings funds, you can’t use them tax free on a given expense and claim the credit, so consider paying the first $4,000 in tuition out of pocket before using 529 funds.

If you have certain foreign income and housing amounts that are excluded or deducted from your AGI, they are added back when calculating MAGI for education tax credits. To claim the full credit, your MAGI must be $80,000 or less ($160,000 or less for those married filing jointly); the credit fully phases out above $90,000 ($180,000 if married filing jointly). The AOTC is partially refundable: 40% of the credit, up to $1,000, may be refundable even if you owe no tax.

This nonrefundable credit covers tuition and related expenses for students enrolled at eligible educational institutions. It can be used for undergraduate, graduate, and professional degree courses, including courses to acquire or improve job skills. The LLC is worth up to $2,000 for each tax return and can be claimed for an unlimited number of years. The credit is calculated as 20% of the first $10,000 in qualifying expenses.

To claim the full credit, your MAGI must be $80,000 or less ($160,000 or less if married filing jointly). The credit phases out completely at $90,000 ($180,000 if married filing jointly).

Tax credits can also encourage saving for retirement or offset taxes you’ve already paid on certain income. Some of these credits apply only in specific circumstances.

If your income falls within certain limits, you may qualify for the saver’s credit, equal to 50%, 20%, or 10% of qualifying contributions to an individual retirement account (IRA), 401(k) plan, or other eligible retirement account. The maximum credit is $1,000 ($2,000 for married couples filing jointly).

For 2026, the income limit to qualify is $40,250 for single filers, $60,375 for heads of household, and $80,500 for married couples filing jointly. The saver’s credit is nonrefundable. Beginning in 2027, the saver’s match will replace it for most qualifying retirement contributions.

If you paid or accrued taxes to a foreign country on income that’s also subject to U.S. tax, you may be able to claim the foreign tax credit, helping to reduce the effects of double taxation. The credit is claimed using Form 1116 in many cases.

If you paid alternative minimum tax (AMT) in a previous year because of certain deferral items, you may be able to claim a credit in a later year. Form 8801 is used to calculate the credit.

The federal tax code includes credits for some homeowners, although federal credits for home energy improvements expired after 2025.

This credit, which is not to be confused with the mortgage interest deduction, helps lower-income taxpayers own a home. You’ll know if you qualify, as you’ll be issued a qualified Mortgage Credit Certificate (MCC) from your state or local government when you get a new mortgage on your home. If you sell your home within nine years, you may have to repay all or part of this credit. The credit is nonrefundable, although you can carry forward unused portions for up to three years.

This credit expired at the end of 2025, so improvements made after December 31, 2025, don’t qualify. For eligible improvements made through 2025, the credit generally covered 30% of costs for solar panels, solar water heating, small wind energy, geothermal heat pumps, and certain other clean-energy property. The credit was nonrefundable, but unused amounts may be carried forward to future tax years.

This credit expired at the end of 2025, so improvements made after December 31, 2025, don’t qualify. For eligible improvements made through 2025, the credit generally covered 30% of certain costs for insulation, exterior doors, windows and skylights, heat pumps, water heaters, and other energy-efficient home improvements. The credit was nonrefundable.

The federal clean vehicle credits expired for vehicles acquired after September 30, 2025, but they may still apply to qualifying vehicles reported on 2025 tax returns. For qualifying electric, plug-in hybrid, and fuel cell vehicles acquired by the deadline, the new clean vehicle credit was worth up to $7,500, subject to income and other requirements. A separate previously owned clean vehicle credit offered up to $4,000 for qualifying used vehicles. The credits were nonrefundable.

The premium tax credit (PTC) helps eligible taxpayers cover premiums for health insurance purchased through the Health Insurance Marketplace at HealthCare.gov. The credit is refundable. Temporary rules that expanded eligibility and increased the credit expired after 2025. For 2026, eligibility is generally limited to households with income between 100% and 400% of the federal poverty level.

Tax credits can provide an incentive for decisions the government wants to encourage, from saving for retirement to paying for higher education. A tax credit shouldn’t justify a purchase or other decision that you wouldn’t have already made. But if you were considering it anyway—earning a college degree, for example—the tax credit may be icing on the cake.

You can also plan to take advantage of tax credits if you have flexibility. And beware: Tax credits can change or expire, as the clean vehicle and home energy credits did in 2025. Your own eligibility can change, too. For example, the child tax credit generally ends once a child turns 17, but if your child enters college, you may become eligible for an education tax credit.

Easy come, easy go.