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Tax Deduction and Credits

Earn Income Credit

The earned income tax credit (EITC) provides additional funds to people who, despite working, receive low to moderate incomes. Easy enough, right? Unfortunately, there are countless rules and exceptions to those rules in determining eligibility for the EITC. Let’s get right to simplifying it for you.

Earned Income Tax Credit Eligibility

To qualify for the EITC, you must have a Social Security Number, work for pay, and earn less than a certain dollar threshold (amounts detailed later). There are many other requirements including USA citizenship/resident alien status and limitations on investment and foreign income, but those are typically not issues for people otherwise qualified for the EITC.

Work for Pay

Unemployment income doesn't’t help you qualify for the EITC. Neither does bank interest. In order to receive any money via the EITC, you must work. You can have a traditional job as an employee or you can be your own boss and earn money from self-employment. But one way or another, you have got to earn some money in order to qualify for the EITC.

Income Limits

For the 2011 tax year (the tax return you’re about to file), your earned income (what you receive due to your work), and your adjusted gross income (AGI, the sum total of all of your earnings less certain deductions) must be less than:

$43,998 ($49,078 married filing jointly) with three or more qualifying children

$40,964 ($46,044 married filing jointly) with two qualifying children

$36,052 ($41,132 married filing jointly) with one qualifying child

$13,660 ($18,740 married filing jointly) with no qualifying children

Qualifying Children

As you can see above, the relevant income limits are much more generous if you take care of at least one qualifying child. Your child qualifies if he or she meets all of the following conditions:

  • Has a valid Social Security Number.
  • Is your child (natural, adopted or foster), grandchild, sibling, step-sibling, half-sibling, niece, or nephew
  • Younger than you and younger than 19, unless a student (in which case your child must be less than 24), or totally and permanently disabled (in which case there is no age limit)
  • Lives with you in the United States for more than half of the year
  • The child doesn't’t file a joint tax return.

Credit vs Deductions

A tax credit lowers your tax bill dollar for dollar. A deduction shaves money off your taxable income, so the value depends on your tax bracket. If you're in the 25% bracket, a $1,000 deduction lowers your tax bill by $250. But a $1,000 credit lowers the bill by the full $1,000, no matter in which bracket you are.

This difference becomes important, for example, if you pay college tuition and you're choosing between taking the Hope tax credit or the tuition deduction. The Hope credit can lower your tax bill by up to $1,650 per child in the first two years of college (the Lifetime Learning credit can reduce your taxes by up to $2,000 after that). To qualify for those tax credits for 2006, though, your income must be less than $110,000 if married filing jointly, or $55,000 for single filers.

Home Energy Credit

Credit worth up to $1,500 for energy-efficient home improvements

You can claim a maximum total energy credit of $1,500 for 2009 and 2010, and the caps on individual items are eliminated. In addition, the old 10 percent credit rate is juiced up to a more robust 30 percent. That means you can reduce your tax bill by 30 percent of what you pay for the following items that meet federal energy-efficiency standards, up to the $1,500 maximum tax savings:

  • Energy-efficient windows
  • Skylights
  • Central air conditioners
  • Electric heat pumps
  • Water heaters
  • Exterior doors
  • Insulation
  • Natural gas, propane or oil furnaces
  • Natural gas, propane or oil hot water boilers
  • Biomass fuel stoves
  • Main air circulating fans
  • Pigmented metal roofs

The manufacturer should be able to tell you which of their products qualify for the souped-up credit. If you claimed the energy credit in the past and used up part or all of your old $500 allotment, don’t worry. You get a fresh start in 2009 and 2010, and can earn a credit of up to $1,500 over those two years. There’s no reduction for any energy credits you took previously. One restriction: You can claim this credit only for improvements made to your primary residence. Here's how the credit works

If you spent $4,000 on energy-saving windows for your home in 2009, you would have claimed a $1,200 credit when you filed your 2009 tax return in 2010. And if you spend $5,000 on qualifying air conditioning equipment in 2010, the credit on your 2010 return would be limited to $300—bringing your total credit up to the $1,500 maximum.