What is a Tax Credit?

Tax preparers are more than used to answering the same questions over and over again. In fact, one of the more common questions that they probably have to answer is the rather simple question of: what is a tax credit? While you could always ask your tax preparer for the answer to this question, why risk distracting them when you can find the general answer to the question yourself? By knowing at least the basics about a tax credit, you can ask more pertinent and timely questions when you are able to have your tax preparer working with you to do your taxes.

• Definition. The first place to begin with understanding tax credits is probably with the actual definition. In simplest terms, a tax credit is an item that is used to reduce the amount of tax that you pay. This is often confused with a very similar item that is known as a tax deduction.
• Common usage. Tax credits are typically offered by the government in an attempt to help promote specific types of behaviors. Some recent examples of this was such programs where you can receive a tax credit for using more energy efficient appliances, or the "Cash for Clunkers" program from a few years ago. Another common type of tax credit that is used quite a lot today is the Earn Income Credit where (in laymen's terms) the tax that you pay is reduced due to the number of children that you have.
• Common effect. The most common effect of tax credits is that the government is trying to encourage certain types of activities that they consider to be beneficial to the whole of society. This is typically a very effective method of promoting certain societal behaviors since the practice, in effect, is allowing the tax payer to have more access to their paychecks. Once again, a good example of this can be found in the Earned Income Credit, which is designed to promote people working at even low paying jobs since they will be able to take more of their paychecks home.
• Should you use them? If you are looking for a quick and easy answer, then a tax credit is generally a good thing. However, before you begin applying for any specific types of tax credits, you really need to talk about their effect and impact on your tax ratings with your tax professional. You may not qualify for all the tax credits that are currently available, or even be aware of all of the ones that you may qualify for. This is where the tax preparer can come in handy and help you out.