What is a tax credit? It's a way for parents, homeowners, and students to lower their taxes

• What is a tax credit? A tax credit is a dollar-for-dollar reduction of your tax bill.
• A tax credit is different than a tax deduction in that it can be claimed regardless of whether you itemize your deductions.
• There are over a dozen tax credits available to individual taxpayers under specific income limits, including credits for caring for children, continuing education, saving for retirement, and owning an energy efficient home.
• Some tax credits are refundable, meaning if you don't have a tax bill large enough to use the full credit, you will get the money as a refund.
• Visit Business Insider's homepage for more stories.

There are a number of ways to legitimately pay less in taxes, and one of the most common is through tax credits.

A tax credit is an amount of money awarded to you, the taxpayer, by the IRS that reduces your tax bill on a dollar-for-dollar basis. It is one of the last steps in calculating your annual tax bill and can be claimed regardless of whether you itemize your deductions.

There are over a dozen tax credits available to individual taxpayers, including credits for caring for children, continuing education, saving for retirement, and owning an energy efficient home. For information on the forms you need to claim tax credits, visit the IRS website.

What is a tax credit?

Tax credits are taken in the final step of the process of calculating your tax liability.

Suppose your gross income for the tax year is $100,000. The next step is to claim "above-the-line" deductions, also known as adjustments to income — part of your self-employment tax or your traditional IRA contribution deduction, for example.

Your gross income minus your above-the-line deductions equals your adjusted gross income (AGI). From there, you subtract the greater of your standard deduction or your itemized deductions from your AGI, arriving at your taxable income. Your taxable income is used to calculate your tax liability — it's the amount of money you'll be taxed on at your marginal tax rate.

Finally, any applicable tax credits are subtracted from your total tax bill. Say your total tax bill is $4,000 and you claim a credit worth $2,000, you will only be responsible for paying $2,000. Some tax credits are refundable, meaning if you don't have a tax bill large enough to use the full credit, you will get the money as a refund.

Tax credits are meant to bring some relief to taxpayers, typically those who earn low- to- moderate income and take care of children, invest in education, save for retirement, or are committed to energy efficiency. Below are a few of the most common tax credits.

Tax credits for families

The Earned Income Tax Credit (EITC) is a popular credit for parents and caretakers. For the 2019 tax year, the EITC awards up to $2,000 per qualifying child — a dependent under 17 who lived with the taxpayer for more than six months of the year — and is refundable up to $1,400. The credit begins to phase out at an AGI of $200,000 for single filers and $400,000 for married couples filing jointly.

The other tax credits for families are the Child and Dependent Care Credit, the Adoption Credit, the Child Tax Credit, and the Credit for the Elderly or Disabled.

There's also a tax credit to help offset the cost of health insurance purchased through the government-run Health Insurance Marketplace. The Premium Tax Credit is available to families whose income is equal to at least 100%, but not more than 400%, of the federal poverty line, though there are some exceptions.

Tax credits for savers

The Saver's Credit enables low- to moderate-income taxpayers saving for retirement in an IRA or employer-sponsored retirement plan to reduce their tax bill by up to $1,000, or $2,000 if married and filing jointly. To be eligible, taxpayers must be at least 18 years old, not a full-time student, and not claimed as a dependent on someone else's return. AGI also must be less than $32,000 for single filers, and less than $46,000 for joint filers.

You can also reduce your tax bill for making investments to save energy with the Residential Energy Credit. Adding solar energy systems to your main home can qualify you for a credit worth 30% of the costs.

Tax credits for students

The American Opportunity Credit gives students, or parents who claim their student as a dependent, up to $2,500 per student education expenses during the first four years of college. If the tax credit reduces your tax bill to zero, up to 40% of the credit can be refunded. The credit phases out at an AGI of $80,000 for single filers and $160,000 for joint filers.

The Lifetime Learning Credit awards up to $2,000 per tax return for qualified costs related to undergraduate, graduate, and professional degree courses. The tax credit is nonrefundable and begins to phase out at an AGI of $57,000 for single filers and $114,000 for joint filers. The Lifetime Learning Credit cannot be claimed alongside the American Opportunity Credit.

Join the conversation about this story »

NOW WATCH: This Disney hotel serves adorable character-themed dim sum