Tax credit

A tax credit is a tax incentive which allows certain taxpayers to subtract the amount of the credit from the total they owe the state.[1] It may also be a credit granted in recognition of taxes already paid or, as in the United Kingdom, a form of state support for low earners.

Incentive tax credits may be used to encourage behaviors like investment or parenting. A credit directly reduces tax bills, unlike tax deductions and tax exemptions, which indirectly reduce tax bills by reducing the size of the base (for example, a taxpayer's income or property value) from which the tax bill is calculated.

Most tax credits are nonrefundable tax credits and so do not apply if no taxes are owed. However, some tax credits are refundable tax credits[2] so if the credit exceeds the amount of taxes owed, the excess is returned to the taxpayer.

Credit for payments

Many systems refer to taxes paid indirectly, such as taxes withheld by payers of income, as credits rather than prepayments. In such cases, the tax credit is invariably refundable. The most common forms of such amounts are payroll withholding of income tax or PAYE, withholding of tax at source on payments to nonresidents, and input credits for value added tax.

Individual income tax credits

Income tax systems often grant a variety of credits to individuals. These typically include credits available to all taxpayers as well as tax credits unique to individuals. Some credits may be offered for a single year only.

Low income subsidies

Several income tax systems provide income subsidies to lower income individuals by way of credit. These credits may be based on income, family status, work status, or other factors. Often such credits are refundable when total credits exceed tax liability.

United Kingdom

In the United Kingdom, the Child Tax Credit and Working Tax Credit are paid directly into the claimant's bank account or Post Office Card Account. In exceptional circumstances, these can be paid by cashcheque (sometimes called giro) however payments may stop if account details are not provided.[3] A minimum level of Child Tax Credits is payable to all individuals or couples with children, up to a certain income limit. The actual amount of Child Tax Credits that a person may receive depends on these factors: the level of their income, the number of children they have, whether the children are receiving Disability Living Allowance and the education status of any children over 16.

Working Tax Credit is paid to single low earners with or without children who are aged 25 or over and are working over 30 hours per week and also to couples without children, at least one of whom is over 25, provided that at least one of them is working for 30 hours a week. If the claimant has children they may claim Working Tax Credit from age 16 upward provided that they are working at least sixteen hours per week.[4]

Tax Credits are capped which many sources claim affects the poorest families disproportionately. A survey by End Child Poverty estimated that roughly 1.5 million parents have reduced spending on basics like food and fuel.[5] According to Gavin Kelly of the Resolution Foundation, tax credits help raise living standards of low paid workers. He wrote in the New Statesman, "Perhaps the biggest misconception is the voguish notion that if tax credits are cut, employers will somehow decide to offer pay rises to fill the gap. This is saloon-bar economics espoused by some on both left and right."[6]

On 15 September 2015, the House of Commons voted[7] to decrease Tax Credit thresholds, a law that came into effect on 6 April 2016.[8] Opponents claimed that it would harm those on low incomes. Simon Hopkins, Chief Executive of charity Turn2us commented "Today's vote in the House of Commons will mean one thing for many of the poorest working families in the UK; they are going to get poorer. Tax credits are a vital source of income for those on a low wage and for many they make up a substantial portion of their monthly income.[9]

The IFS supported the opposition view that the effects of the changes would disproportionately reduce the income of poor families, even taking into account reductions in income tax and an increase in the National Living Wage.[10] The government responded that the tax credit system had, for too long, been used to subsidise low pay and the changes would bring total expenditure on tax credits back down to more sustainable levels seen in 2007–08.[7]

On 26 October 2015 the House of Lords supported a motion from Baroness Meacher delaying the imposition of the cuts until a new consideration of the effects could be made by the House of Commons.[11]

United States

The U.S. system grants the following low income tax credits:

Family relief

Some systems grant tax credits for families with children. These credits may be on a per child basis or as a credit for child care expenses.

The U.S. system offers the following nonrefundable family related income tax credits (in addition to a tax deduction for each dependent child):

Education, energy and other subsidies

Some systems indirectly subsidize education and similar expenses through tax credits.

The U.S. system has the following nonrefundable credits:

Business tax credits

Many systems offer various incentives for businesses to make investments in property or operate in particular areas. Credits may be offered against income or property taxes, and are generally nonrefundable to the extent they exceed taxes otherwise due. The credits may be offered to individuals as well as entities. The nature of the credits available varies highly by jurisdiction.

United States

U.S. income tax has numerous nonrefundable business credits. In most cases, any amount of these credits in excess of current year tax may be carried forward to offset future taxes, with limitations. The credits include the following (for a full list see section 38 of the Internal Revenue Code):

Many sub-Federal jurisdictions (states, counties, cities, etc.) within the U.S. offer income or property tax credits for particular activities or expenditures. Examples include credits similar to the Federal research and employment credits, property tax credits, (often called abatements), granted by cities for building facilities within the city, etc. These items often are negotiated between a business and a governmental body, and specific to a particular business and property.

Federal nonrefundable investment tax credits

Tax credits, while they come in many forms, are authorized incentives under the Internal Revenue Code (and some state tax codes) to implement public policy. Congress, in an effort to encourage the private sector to provide a public benefit, allows a participating taxpayer a dollar for dollar reduction of their tax liability for investments in projects that probably would not occur but for the credits.

Federal Historic Rehabilitation Tax Credit

The legislative incentive program to encourage the preservation of “historical buildings”. Congress instituted a two-tier Tax Credit incentive under the 1986 Tax Reform Act. A 20% credit is available for the rehabilitation of historical buildings and a 10% credit is available for non-historic buildings, which were first placed in service before 1936. Benefits are derived from tax credits in the year the property is placed in service, cash flow over 6 years and repurchase options in year six.[21]

Renewable Energy/Investment Tax Credit (ITC)

The investment tax credit is allowed section 48 of the Internal Revenue Code. This investment tax credit varies depending on the type of renewable energy project; solar, fuel cells ($1500/0.5 kW) and small wind (< 100 kW) are eligible for credit of 30% of the cost of development, with no maximum credit limit; there is a 10% credit for geothermal, microturbines (< 2 MW) and combined heat and power plants (< 50 MW). The ITC is generated at the time the qualifying facility is placed in service. Benefits are derived from the ITC, accelerated depreciation, and cash flow over a 6-8 year period.[22]

Though set to expire at the end of 2015, the ITC for residential solar installations was renewed in December 2015. The credit will continue at 30% through 2018, and will slowly decline to 10% in 2022. The ITC for other technologies (including geothermal) was extended by one year.[23] Installations will be considered eligible for the ITC based on the date that construction starts.[24]

Renewable Energy/Production Tax Credit (PTC)

Section 45 of the Internal Revenue Code allows an income tax credit of 2.3 cents/kilowatt-hour (as adjusted for inflation for 2013[25]) for the production of electricity from utility-scale wind turbines, geothermal, solar, hydropower, biomass and marine and hydrokinetic renewable energy plants. This incentive, the renewable energy Production Tax Credit (PTC),[26] was created under the Energy Policy Act of 1992 (at the value of 1.5 cents/kilowatt-hour, which has since been adjusted annually for inflation).[27] In late 2015 a large majority in Congress voted[28] to extend the PTC for wind and solar power for 5 years and $25 billion. Analysts expect $35 billon of investment for each type.[29]

Low Income (Affordable) Housing Tax Credit (LIHTC)

Under this program, created in the 1986 Tax Reform Act, the U.S Treasury Department allocates tax credits to each state based on that states population. These credits are then awarded to developers who, together with an equity partner, develop and maintain apartments as affordable units. Benefits are derived primarily from the tax credits over a 10-year period.

Qualified School Construction Bond (QSCB)

QSCBs are U.S. debt instruments used to help schools borrow at nominal rates for the rehabilitation, repair and equipping of their facilities, as well as the purchase of land upon which a public school will be built. A QSCB holder receives a Federal tax credit in lieu of an interest payment. The tax credits may be stripped from QSCB bonds and sold separately. QSCBs were created by Section 1521 of the American Recovery and Reinvestment Act of 2009. Internal Revenue Code Section 54F also addresses QSCBs.

Work Opportunity Tax Credit (WOTC)

The Work Opportunity Tax Credit (WOTC) is a federal tax credit providing incentives to employers for hiring groups facing high rates of unemployment, such as veterans, youths and others. WOTC helps these targeted groups obtain employment so they are able to gain the skills and experience necessary to obtain better future job opportunities. The WOTC is based on the number of hours an employee works and benefits the employer directly.

In December 2014, the credit was extended retroactively to the beginning of 2014 by the Tax Increase Prevention Act of 2014 (TIPA), P.L. 113-295.[30] That act authorized the credit only through December 31, 2014.[31]

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) [32] was part of the American Recovery and Reinvestment Act, which was signed into law in February 2009. The AOTC replaced the Hope Scholarship credit for Tax Years 2009 and 2010, increased the benefits for nearly all Hope credit recipients and many other students by providing a maximum benefit up to $2,500 per student, 100 percent of their first $2,000 in tuition and 25 percent of the next $2,000, expanding the income range over which taxpayers can claim a credit, and making the credit partially refundable. Critics have complained that complexity and restrictions on eligibility make the actual benefits per post-secondary student much lower than the theoretical maximum, and that even with tax credits, higher education remains tax-disadvantaged compared to other investments.[33]

State tax credits

Approximately 43 states provide a variety of special incentive programs that utilize state tax credits. These include Brownfield credits, Film Production credits, Renewable energy credits, Historic Preservation credits and others. The amount of credit, the term of credit and the cost of the credit differs from state to state. These credits can be either in the form of a certificate, which can be purchased as an asset, or in a more traditional pass through entity. The tax credits can generally be used against insurance company premium tax, bank tax and income tax.

Value added tax

Resellers or producers of goods or providers of services (collectively, providers) must collect value added tax (VAT) in some jurisdictions upon billing or being paid by customers. Where these providers use goods or services provided by others, they may have paid VAT to other providers. Most VAT systems allow the amount of such VAT paid or considered paid to be used to offset VAT payments due, generally referred to as an input credit. Some systems allow the excess of input credits over VAT obligations to be refunded after a period of time.

Foreign tax credit

Income tax systems that impose tax on residents on their worldwide income tend to grant a foreign tax credit for foreign income taxes paid on the same income. The credit often is limited based on the amount of foreign income. The credit may be granted under domestic law and/or tax treaty. The credit is generally granted to individuals and entities, and is generally nonrefundable. See Foreign tax credit for more comprehensive information on this complex subject.

Credits for alternative tax bases

Several tax systems impose a regular income tax and, where higher, an alternative tax. The U.S. imposes an alternative minimum tax based on an alternative measure of taxable income. Mexico imposes an IETU based on an alternative measure of taxable income. Italy imposes an alternative tax based on assets. In each case, where the alternative tax is higher than the regular tax, a credit is allowed against future regular tax for the excess. The credit is usually limited in a manner that prevents circularity in the calculation.

See also


  1. Piper, Mike (Sep 12, 2014). Taxes Made Simple: Income Taxes Explained in 100 Pages or Less. Simple Subjects, LLC. ISBN 978-0-9814542-1-4.
  2. The OECD uses the term "wastable" to mean refundable in some analyses, though this term is not used by English language tax systems.
  3. "HM Revenue & Customs – Reasons why your tax credits might go down or stop". Retrieved 16 March 2011.
  4. Child Poverty Action Group Welfare benefits and tax credits handbook, 2011/12
  5. Rampen, Julia (22 May 2015). "Benefits cap leaves children hungry and cold - how to survive it".
  6. "The decline of tax credits: a tale of wishful thinking and saloon-bar logic".
  7. 1 2 BBC (London) 15 September 2015 Commons back Osborne plan for tax credit cuts
  8. Tax Credits (Income Thresholds and Determination of Rates) (Amendment) Regulations 2015 UK Draft Statutory Instruments, Retrieved 26 October 2015
  9. Parliament has voted, must charities take up the slack? Turn2us, Politics Home, 16 September 2015, retrieved 26 October 2015
  10. Moore, Sinead (11 September 2015). "IFS hits back at new higher 'living wage'". Economia. Institute of Chartered Accountants in England and Wales. Retrieved 4 March 2016.
  11. The Independent (London) 27 October 2015 "Tax credits: House of Lords votes to delay cuts by three years"
  12. "Tax Breaks for Single Parents". SMG. Retrieved 2014-10-12.
  13. IRS form 8800, 2014 tax year
  14. Presti and Naegele Tax Newsletter, FAQ: What tax breaks come with raising a child?, February 2012.
  15. "Types of Working for Families Tax Credits (Understanding Working for Families Tax Credits)".
  16. Lifetime Learning Credit
  17. "Energy Incentives for Individuals: Questions and Answers". Retrieved 15 May 2014.
  18. "Alternative Motor Vehicle tax Credit". IRS. Retrieved 29 September 2011.
  19. "Fuel Tax Credits and Refunds". IRS. Retrieved 29 September 2011.
  20. "Tax law changes related to disaster relief". IRS. Archived from the original on October 7, 2011. Retrieved 30 September 2011.
  21. "A Guide to the Federal Historic Preservation Tax Incentives". National Park Service. Archived from the original on August 4, 2011. Retrieved 30 September 2011.
  22. US Internal Revenue Code - Title 26 (PDF) U.S. Government Publishing Office, Retrieved 12 December 2015
  23. Renewables Boom Expected Thanks to Tax Credit Scientific American, Retrieved 28 April 2016
  24. BUSINESS ENERGY INVESTMENT TAX CREDIT (ITC) U.S. Department of Energy, Retrieved 28 April 2016
  25. "Internal Revenue Bulletin: 2013–22". Retrieved 15 May 2014.
  26. Renewed Tax Credit Buoys Wind-Power Projects, March 21, 2013 New York Times
  27. "Federal Renewable Electricity Production Tax Credit (PTC)". DSIRE. Archived from the original on September 29, 2011. Retrieved 30 September 2011.
  28. "U.S. wind industry leaders praise multi-year extension of tax credits". Retrieved 15 November 2016.
  29. Randall, Tom (17 December 2015). "Forget Oil Exports—What Just Happened to Solar is a Really Big Deal" via
  30. "President Signs Extenders Package, ABLE Act, IRS Budget Cut" (PDF). Walters Klewer: CCH. December 22, 2014. Retrieved 2015-06-15.
  31. Schreiber, Sally P. (February 19, 2015). "Employers have more time to claim work opportunity tax credit". Journal of Accountancy. Retrieved 2015-06-15.
  32. "the American Opportunity Tax Credit" (PDF). US Department of the Treasury. Archived from the original (PDF) on September 25, 2012. Retrieved 2012-06-26.
  33. Simkovic, Michael (2015). "The Knowledge Tax". University of Chicago Law Review. 82: 1981.

External links

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