Tax credits you don’t want to miss

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By Eva Rosenberg, MarketWatch

LOS ANGELES (MarketWatch) — Whether you itemize or not, you may be eligible for tax credits that can slash your tax bill — and put money in your pocket.

Tax credits break down into two broad categories — nonrefundable and refundable. Nonrefundable credits can wipe out your taxes. But if the credit is higher than your tax liability, you lose it. It disappears.

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Refundable credits are nifty. You get money back from the IRS, even if you paid nothing in. Of course, they are also a major target of tax fraud. Refundable credits attract bogus tax preparers, who churn out thousands of fraudulent tax returns. Just last month, the IRS announced a 30-month prison sentence for Luciano Martinez, a Plano, Texas, tax preparer.

Martinez was responsible for between $400,000 and $1 million worth of bogus refunds, due to excess expenses and fraudulent Hope Credit claims. Read more about that case and others on this IRS page.

Credits are easier to understand if we group them together by related types of expenditures.

Education credits

We lost the Hope credit, so we’re just down to two choices — the American Opportunity credit and the Lifetime credit. You may select only one per student, per year. But if you have more than one student in your household, you might be able to take advantage of each credit.

American Opportunity credit (refundable): Up to $2,500 tax credit per student is based on 40% of your tuition and fees. It also covers costs of books, supplies and course-related equipment. You can use this for four years of college (no grad school).  An added bonus when you have no tax liability: $1,000 of the credit is refundable.

Lifetime Learning Credit (nonrefundable): This $2,000 credit, per tax return, is based on tuition and fees only. You can use this credit year after year, because it covers undergraduate, graduate and job-skills courses.

Read more about education credits and tuition-and-fees deductions on the IRS site.

Child-related credits

These are probably the most-used credits. And some, like the earned-income credit and additional child tax credit, are the most abused. In fact, the IRS has said that tax returns claiming an EIC are routinely run through an extra screening process before refunds are issued.

Earned-income tax credit (refundable): On your 2010 return, the credit is worth up to $3,050 for one child, $5,666 ($5,751 in 2011) for three children. It is $457 with no children ($464 in 2011). To get this credit, you must have income from a job, or business profits. Your total income must be less than certain limits. You cannot have more than $3,100 of investment income ($3,150 in 2011).

In the past, workers could get part of this money in advance, as part of their payrolls. But due to the budget crunch, the Education Jobs and Medicaid Assistance Act of 2010 repealed the advance earned-income tax credit payments. Learn more about the EITC on this IRS page.

Child tax credit (nonrefundable): Worth up to $1,000 per child. Although this credit is limited to your tax liability, the additional child tax credit is refundable, and can apply to each child. Learn more on this IRS page.

Child and dependent care credit (nonrefundable): This credit ranges from $600 to $1,050 per child, for up to two children. However, the higher credit is based on such a low level of income — people earning $15,000 or less are not apt to have taxes as high as $1,050. Although both parents must work to qualify for the credit, there are two ways to get this credit if one or both parents do not work. When either parent is a full-time student or permanently disabled, there’s a special phantom income allocation. If you have over $3,000 in expenses per dependent, in certain cases, some expenses may be used as medical deductions. Job-related benefits may reduce the credit. Read more on this IRS page.

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