Credits reduce the amount of tax calculated on the tax return,known as tax liability?

Question

what does this statement mean??Credits reduce the amount of tax calculated on the tax return,known as tax liability.

What exactly does term "credit " mean in tax term.

Additional Details

Thanks for ur answers..now 1 more question rises (i know it might be lame question but since i am learning basic course have confusions) how wld u explain "tax liability"?

Thanks

Answer 1

A tax credit works just like a store credit.

Think about it this way. If you had a $20 store credit to Wal-Mart, you could use it to reduce the price of a purchase by $20.

Tax credits work the same way. A $1,000 tax credit reduces the taxes you have to pay by $1,000.

Tax credits are broken into 2 basic categories: refundable credits, and non-refundable credits.

On your 1040 form, non-refundable credits are applied first. They count toward your taxes but if you have enough credits to reduce your tax liability to $0, then you loose any remaining amount, it won't be refunded to you. For example, if someone's tax liability was $800 and they had a $1,000 tax credit, then the tax credit would reduce the amount they have to pay down to $0, but they other $200 is lost.

Refundable credits are applied last (at the same time as tax payments). They count first as credits toward taxes due and any remaining amounts can be refunded to the person. In this situation, if a person had a tax liability of $800 and had a $1,000 refundable credit, it would reduce the amount they have to down to $0 and they would get the extra $200 added to their refund. This is how some people get tax refunds that are actually more than they paid in.

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Answer 2

A credit against tax directly reduces the amount of tax you owe.

If you owed $1000 in tax, but then you got a $100 credit, you would only owe $900 in tax.

Contrast a deduction, which is a subtraction from taxable income. Deductions are not subtracted from the tax you owe; they are subtracted from the income you received.

You take deductions before computing the amount of tax you owe; you take credits after computing the amount of tax you owe, then subtract the amount of the credit from the tax. That's why credits are on page 2 of Form 1040, below the place where you calculate taxable income and tax.

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Answer 3

let's say your tax liability is $1000 and you have child credits for two children amounting to $2000
only $1000 of that credit is used to wipe out the tax liability of $1000
but later the 'additional child credit' of the remaining $1000 is applied to any refund you may be due(if you had more than $1000 withheld on your W-2)
you could also be eligible for the EIC credit which would increase your refund by that amount

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