Tax Credit

Law Dictionary: Tax Credit

A dollar for dollar reduction in the amount of tax that a taxpayer owes. Unlike deductions or exemptions, which reduce the amount of income subject to tax, a credit reduces the actual amount of tax owed.

investment tax credit credits allowed for investments in personal property devoted to business or income-producing activity for tax years prior to 1986, I.R.C. §38 and §§46-50.

targeted jobs credit a credit allowed to businesses for increasing the number of employees they hire. I.R.C. §51.53.

The term tax credit described two different concepts:

• The first is a recognition of partial payment already made towards taxes due.
• The second is a state benefit paid to employees through the tax system, which has the effect of increasing (rather than reducing) net income.

 

• 1Tax credits in recognition of tax already deducted
• 2Tax credits as a form of state benefit
• 3Tax credits and minimum wage
• 4Tax credits and tax deductions

[top]Tax credits in recognition of tax already deducted

Within the Australian, Canadian, United Kingdom, and United States tax systems, a tax credit is a recognition of partial payment already made towards taxes due. A similar concept exists under different names in the French tax system. This situation arises, for example, when standard rate tax has been deducted at source ("withholding tax"), but the tax-payer is subject to further taxation at a higher rate.

[top]Tax credits as a form of state benefit

Tax credits may be characterized as either refundable or non-refundable, or equivalently non-wastable or wastable. Refundable or non-wastable tax credits can reduce the tax owed below zero, and result in a net payment to the taxpayer beyond their own payments into the tax system, appearing to be a moderate form of negative income tax. Examples of refundable tax credits include the earned income tax credit and the additional child tax credit in the U.S., and the working tax credits or child tax credits in the UK.

A non-refundable or wastable tax credit cannot reduce the tax owed below zero, and hence cannot cause a taxpayer to receive a refund in excess of their payments into the tax system. Some examples of non-refundable tax credits are the Hope and Lifetime Learning educational tax credits in the U.S. or the former children's tax credit in the UK. Another example would be declared gifts made to registered charities in the UK under the current Giftaid scheme, which attract tax relief (claimed by the charity) at the standard rate but which cannot reduce the donor's liabilty beyond the amount of tax actually paid by them in a given year.

[top]Tax credits and minimum wage

Tax credits are like a means tested benefit paid direct to employees to encourage them into work. In the United Kingdom, employees are paid either the ‘child tax credit’ or ‘working tax credit’ through the payroll, with the employer deducting the equivalent amount from its total amounts due to HM Revenue and Customs. Single low earners working over 16 hours per week and couples working 30 hours combined are eligible. If one supports children, the supplements are greater. Two issues are being addressed, the so-called employment and poverty traps. That means the disincentive to work when expected wages are little more than unemployment benefits, and the difficulty for workers to break above a net earning margin faced with not just income tax, but national insurance, VAT, student loan repayments and other cumulative tax burdens.

This indirect wage regulation forms an important part of income for low earners and their families. It reduces the stigma of collecting benefits for workers and perhaps even shifts it to employers, who become very aware they are giving staff low pay. It is not a direct cost to employers in the way a National Minimum Wage is, but in some cases it has been found that employers put pressure on workers to do fewer hours to avoid extra tax forms. Some commentators have suggested that raising the personal allowance could achieve a similar effect for single workers with reduced administrative burden for both employers and the Inland Revenue.

[top]Tax credits and tax deductions

A tax credit is generally more valuable than an equivalent tax deduction or tax allowance because a tax credit reduces tax directly, while a deduction or allowance only reduces taxable income and so the reduction in tax is only a fraction (the marginal tax rate) of the deduction or allowance.

In the United States beginning in tax year 2006, consumers will be able to itemize purchases on their federal income tax form, which will lower the total amount of tax they owe the government.



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