Tax Credit

Tax credits reduce the amount of taxes you owe, dollar for dollar. So, if you owe $1,500 in federal income tax and you qualify for a $500 tax credit, your tax bill goes down to $1,000. This generally makes tax credits more powerful than deductions, which only reduces how much of your income is taxed. Making it important to know what types of tax credits are out there, and how you can use them to your advantage.

Tax Credits - Why they're important

Tax credits are important because they directly reduce the amount of tax you owe - dollar for dollar. This makes them one of the more powerful tools in the tax code for lowering someone's actual tax bill.

Lower Tax Bill

They lower your tax bill more effectively than deductions.

A deduction reduces your taxable income.

A credit reduces your tax liability itself.

For example:

A $1,000 deduction might save you $120-$240 depending on your tax bracket.
A $1,000 tax credit saves you a full $1,000 - no matter your income bracket.

Encourages Behaviors

Tax credits can encourage certain behaviors.

Congress uses tax credits to push public-policy goals, like:

Switching to clean energy (solar, EVs, heat pumps).
Attending college (education credits).
Adopting a child.
Saving for retirement.
Supporting low-income households (EITC, Child Tax Credit).

Credits reward people for taking actions that benefit the economy or society.

Equability and Economic Growth

Some credits, especially refundable credits, can increase a refund even if you owe no tax. These credits help lower-income households stay afloat and often lead many people to:

Buy homes
Purchase electric vehicles
Invest in businesses
Improve energy efficiency

When millions get taxes back, or make these purchases, it helps boost industries, jobs, and the economy as a whole.

Tax Credits - Types of Tax Credits

There is many types of tax credits, but there are three main types of credits, each serving its own unique purpose.

Nonrefundable Tax Credit

These credits can reduce your tax to $0, but cannot give you a refund beyond that. If the credit is larger than your tax liability, the leftover amount disappears.

Examples:

Child and Dependent Care Credit
Lifetime Learning Credit
Saver's Credit (Retirement contributions)
Foreign Tax Credit
Some clean-energy home improvement credits

Great for lowering you tax - but if you owe nothing, you don't get extra money back.

Refundable Tax Credits

These credits are the most powerful. If the credit is larger than your tax liability, the IRS pays you the difference as a refund.

Examples:

Earned Income Tax Credit (EITC)
American Opportunity Tax Credit (partially refundable)
Premium Tax Credit (health insurance marketplaces)

Refundable credits can create or increase a refund even when you owe zero tax.

Partially Refundable Tax Credits

A hybrid: part of the credit can exceed your tax and trigger a refund, while the rest cannot.

Examples:

American Opportunity Tax Credit (40% refundable up to $1,000)
Child Tax Credit (additional amount may be refundable depending on rules for that year)

You get the best of both worlds - some guaranteed refund potential, plus additional nonrefundable benefits.

Other Ways Credits are Categorized

You will also see credits grouped by purpose.

Home & Energy Credits:

Residential Clean Energy Credit
Energy Efficient Home Improvement Credit
EV (Electric Vehicle) Tax Credit

Education Credits:

American Opportunity Tax Credit
Lifetime Learning Credit

Family & Work Credits:

Child Tax Credit
Child and Dependent Care Credit
Earned Income Tax Credit

Business & Employer Credits:

Small Business Health Care Tax Credit
R&D Credit
Work Opportunity Tax Credit

Tax Credits - What is changing 2025-2026

There are a number of tax credits that are changing for 2025-2026 (or have recently changed), thanks to new legislation. Some credits are being expanded or indexed for inflation, while many energy- and clean-vehicle-related credits are being reduced or eliminated.

Increased or Adjusted

Here a credits being increased or adjusted in 2025-2026.

Child and Dependent Care Tax Credit - Starting with tax year 2026, the rate used to compute this credit is permanently increased: taxpayers can claim 50% of qualifying childcare expenses (up from a lower percentage).
Earned Income Tax Credit (EITC) - For 2026, the maximum EITC for a taxpayer with three or more qualifying children increases somewhat (for example, to $8,231) compared with 2025.
Adoption Tax Credit - For 2026 the maximum credit amount rises (qualified adoption expenses eligible go up), with part of the credit potentially refundable.

These increases mean that for families and lower- to middle income earners, some of the major "people and family-oriented" credits may offer modestly more benefit in the coming tax years.

Phased Out, Limited, or Eliminated

Under the new tax and budget law (the "One, Big, Beautiful Bill Act" or OBBBA), several clean-energy and green-vehicle tax incentives are being reduced or discontinued.

Clean Vehicle Tax Credit - No longer available for new plug-in or clean vehicles placed in service after September 30, 2025.
Previously Owned Clean Vehicle Credit - The credit for used electric vehicles is also being eliminated.
Residential Clean Energy Credit - Credits for solar panels, small wind, geothermal, and similar installations end for property placed in service after December 31, 2025.
Energy Efficient Home Improvement Credit - This credit will also expire after December 31, 2025.
Other renewable-energy credits - Incentives for certain wind, solar, or other clean-energy projects will face stricter deadlines and eligibility limits.

In short, anyone planning to purchase a qualifying EV, install solar panels, heat pumps, or make other energy-related upgrades should act before 2026, as many of these credits will largely disappear.