1

STUDY UNIT EIGHT

TAX CREDITS AND PAYMENTS

8.1 Tax Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

8.2 Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

The first subunit discusses tax credits, which are used to achieve policy objectives such as
encouraging energy conservation or providing tax relief to low-income taxpayers. A $1 credit reduces
gross tax liability by $1. Various nonrefundable and refundable tax credits are available. Most credits
are nonrefundable, meaning that once the tax liability reaches zero, no more credits can be taken to
produce refunds. Nonrefundable personal credits include the
● Foreign Tax Credit
● Lifetime Learning Credit
● Child and Dependent Care Credit
● Child Tax Credit
● Credit for Other Dependents
● Retirement Savings Contribution Credit
● Credit for the Elderly or Disabled
● Adoption Credit
● Residential Mortgage Interest Credit
● Minimum Tax Credit
● Residential Energy Credit
● Clean Vehicle Credit
Refundable credits are treated as payments and can result in refunds for the taxpayer.
Refundable credits include the
● American Opportunity Tax Credit
● Additional Child Tax Credit
● Earned Income Credit
● Health Insurance Premium Tax Credit
In the last subunit, we discuss payment requirements, claims for refunds, and the statute of
limitations.

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2 SU 8: Tax Credits and Payments

8.1 TAX CREDITS

Foreign Tax Credit (FTC)
1. A taxpayer may elect either a credit or a deduction for taxes paid to other countries or U.S.
possessions.
a. Generally, the FTC is applied against gross tax liability after nonrefundable personal
credits and before all other credits.
b. The FTC, as modified, may offset AMT liability.
1) The FTC is not creditable against the accumulated earnings tax (AET) or the
personal holding company (PHC) tax.
c. Pass-through entities apportion the foreign taxes among the partners, shareholders (of
an S corporation), or beneficiaries (of an estate).
1) The taxpayers then elect and compute a credit or deduction on their personal returns.
d. For a non-U.S. person, the FTC is allowed only for foreign taxes paid on income
effectively connected with conduct of a trade or business in the U.S. and against U.S. tax
on the effectively connected income.
1) Nonresident aliens and foreign corporations are included under this provision.
e. Qualified foreign taxes (QFTs) include foreign taxes on income, war profits, and excess
profits.
1) QFTs must be analogous to the U.S. income tax.
a) They must be based on a form of net annual income, including gains.
b) Concepts such as realization should be incorporated into the tax structure.
2) Foreign taxes paid on foreign earned income or housing costs excluded as
excessive may neither be credited nor deducted.
3) Deemed QFT. A domestic corporation that owns at least 10% (voting) of a
foreign corporation is deemed to have paid the foreign taxes paid by the foreign
corporation on income that it distributed to the domestic corporation as a dividend.

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 SU 8: Tax Credits and Payments 3

f. FTC limit. The maximum amount of tax that may be credited is computed using the
following formula:
U.S. income Foreign earned taxable income
FTC = ×
tax before FTC Worldwide taxable income
1) The limit must be applied separately to nonbusiness interest income and all other
income.
2) The amount used for TI in the numerator and denominator is regular TI with
adjustments.
3) The credit is limited by foreign taxes paid or accrued during the tax year.
g. The FTC is claimed on Form 1116, Foreign Tax Credit, unless the taxpayer meets all of
the following conditions and elects to claim the credit on Schedule 3 (Form 1040), line 1:
1) The taxpayer is an individual,
2) The only foreign source income for the year is passive income that is reported on a
qualified payee statement (e.g., Form 1099-DIV, Form 1099-INT, Schedule K-1, or
Schedule K-3), and
3) The QFTs for the year do not exceed $300 ($600 for a joint return).
h. Carryover. Foreign tax paid in excess of the FTC limit may be carried back 1 year and
forward 10, in chronological order. The carryover is treated as foreign tax paid subject to
the FTC limit.
1) The carryover may not be applied in any year when a deduction for foreign taxes is
taken (in lieu of the FTC).
i. A credit (or deduction) cannot be taken for foreign income taxes paid on income that is
excluded from U.S. tax under the foreign earned income exclusion.
j. A choice must be made to take either a credit or a deduction for all qualified foreign taxes.

EXAMPLE 8-1 Foreign Tax Credit

Maria had an AGI of $100,000 in 2023, of which $80,000 was wages earned in the United States and
$20,000 was unqualified foreign dividend income. She paid $4,000 of foreign taxes on the dividend income.
Maria’s 2023 tax liability before the FTC is $15,000. The portion of U.S. tax liability assigned to foreign
income is $3,000 ($15,000 × $20,000 ÷ $100,000). Maria is able to claim a $3,000 Foreign Tax Credit on
Form 1116 and has $1,000 ($4,000 taxes paid – $3,000 allowed credit) of unused Foreign Tax Credit that
can be carried back to 2022 or forward through 2033.

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4 SU 8: Tax Credits and Payments

Education Credits
2. Two tax credits may be elected by low- and middle-income individuals for education expenses
incurred by students pursuing higher education or vocational training.
a. The American Opportunity Tax Credit is partially refundable, and the Lifetime Learning
Credit is nonrefundable. In addition, neither credit is allowed by married taxpayers who
file separately; i.e., they must file a joint return.
b. American Opportunity Tax Credit (AOTC). The AOTC provides a maximum credit of
$2,500 per student for each of the first 4 years of post-secondary education.
1) The $2,500 per year is the sum of 100% of the first $2,000 of qualified expenses and
25% of the next $2,000 of qualified expenses.
2) The credit applies to the first 4 years of higher education received by the taxpayer,
the taxpayer’s spouse, and/or the taxpayer’s dependents.
3) The credit applies to tuition and tuition-related fees, books, and other required
course materials.
a) The credit is not allowed for room and board, insurance, student health fees,
transportation costs, activity fees, or any other fees or expenses not related to
the student’s academic course of instruction.
4) Qualified education expenses paid in 2023 for an academic period that begins in the
first 3 months of 2024 can be used in figuring an education credit for 2023.
5) The credit cannot be claimed if
a) An exclusion for an education IRA or a state tuition program is claimed for the
same expenses
b) The student has been convicted of a federal or state felony offense consisting
of the possession or distribution of a controlled substance
c) The student is not taking at least one-half of the normal full-time workload for
at least one academic period that begins during the calendar year in which
the credit is claimed
6) The credit phases out for MAGI between $80,000 and $90,000 for single taxpayers
and between $160,000 and $180,000 on a joint return.
7) Up to 40% of the credit is refundable.
a) When the original tax equals or exceeds $2,500, the entire $2,500 is used to
lower the tax bill. Thus, no credit will be refunded.
b) When the original tax is less than $2,500 and the tax is lowered to zero, the
remaining credit is partially (40%) refundable. For example, the original tax is
$1,500. After $1,500 of the credit is used to lower the tax to zero, 40% (i.e.,
$400) of the remaining $1,000 credit is refundable.
c) No refund of the credit is allowed if the student is a child subject to the “kiddie
tax” (covered in Study Unit 1, Subunit 5).

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 SU 8: Tax Credits and Payments 5

c. Calculating the American Opportunity Tax Credit

1) Step 1: Calculate the maximum AOTC for each student based on 100% of the first
$2,000 of qualified expenses and 25% of the next $2,000 of qualified expenses. If
there is at least $4,000 of qualified expenses, the maximum per-student AOTC is
$2,500.
2) Step 2: Add the maximum AOTCs for each qualified student to find the maximum
AOTC for all students.
3) Step 3: If MAGI is $160,000 or less for married taxpayers filing jointly or $80,000 or
less for all others, the maximum AOTC for all students is the result of Step 2. MAGI
is below the phaseout amount.
a) If MAGI is $180,000 or more for married taxpayers filing jointly or $90,000 or
more for all others, the maximum AOTC is zero. MAGI is above the upper
threshold and the AOTC is phased out.
b) If MAGI is between $160,000 and $180,000 for married taxpayers filing jointly
or between $80,000 and $90,000 for all others, the AOTC is computed as
follows:
Maximum AOTC for $180,000 (if joint return) or $90,000 (all others) – MAGI
×
all students (Step 2) $20,000 (if joint return) or $10,000 (all others)

4) Step 4: Compare the results from Step 3 to the federal income tax liability.
a) If the federal income tax liability is greater than the results of Step 3, Step 3 is
a nonrefundable AOTC.
b) If the results of Step 3 are greater than the federal income tax liability, the
amount of the federal income tax liability becomes a nonrefundable AOTC.
The refundable portion of the AOTC is 40% of the excess of Step 3 over the
federal income tax liability.

EXAMPLE 8-2 American Opportunity Tax Credit

Jack and Jill Smith, married taxpayers who file a joint return, have a combined modified AGI of $172,000.
They paid $3,000 in tuition expenses for their dependent daughter, who is in her second year of college,
and $8,000 in tuition expenses for their dependent son, who is in graduate school. The tuition expenses the
Smiths paid for their son do not qualify for the AOTC because he is not in his first 4 years of post-secondary
education.
The $3,000 of tuition expenses paid for their daughter’s education qualifies for the credit. The tentative credit
allowed is $2,250 [($2,000 × 100%) + ($1,000 × 25%)]. However, the Smiths’ AGI is within the phase-out
range and their credit must be reduced accordingly. The Smiths’ allowable credit is calculated as follows:
$2,250 × [($180,000 – $172,000) ÷ $20,000] = $900

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6 SU 8: Tax Credits and Payments

d. Lifetime Learning Credit. The Lifetime Learning Credit provides a credit of 20% of
qualified tuition expenses paid by the taxpayer for any year the AOTC is not claimed for
the same student.
1) The maximum credit allowed per year is $2,000.
2) This is based on 20% of up to $10,000 of qualified tuition and fees paid for the
taxpayer, the taxpayer’s spouse, and/or the taxpayer’s dependents.
3) The credit is figured on a per-taxpayer basis, whereas the AOTC is allowed per
student.
4) The credit is available for an unlimited number of years and can be used for both
graduate- and undergraduate-level courses.
5) Eligible expenses for this credit include tuition and fees required for enrollment.
6) The Lifetime Learning Credit phases out for AGI between $80,000 and $90,000 for
single filers and between $160,000 and $180,000 for those filing a joint return.
e. The credits may not be used for room and board, activity fees, athletic fees, insurance
expense, or transportation.
f. The tuition statement (1098-T) provided to the taxpayer/student is required to include the
name, address, and TIN of the taxpayer/student.

EXAMPLE 8-3 Lifetime Learning Credit

Barney is a single taxpayer with a modified AGI of $52,000. Barney has two dependent daughters in
graduate school. He pays $6,000 in tuition expenses for each of his daughters, for a total of $12,000. The
first $10,000 of these expenses qualifies for the Lifetime Learning Credit. Thus, Barney may claim a credit of
$2,000 ($10,000 × 20%). There is no phaseout of the Lifetime Learning Credit for Barney because the credit
phaseout for single taxpayers commences when modified AGI is $80,000 and ends at $90,000.

EXAMPLE 8-4 Lifetime Learning Credit

Weasley and Brandy Kat, who file a joint tax return, have an adjusted gross income (AGI) of $158,000 for
2023. Their daughter Honey began her first year of graduate school on July 21, 2022. Weasley and Brandy
incurred tuition expenses of $12,000 in 2023.
A Lifetime Learning Credit is limited to 20% of the first $10,000 of tuition paid. The Lifetime Learning Credit
is available in years the American Opportunity Tax Credit is not claimed. The Kats’ credit for 2023 will be
$2,000 ($10,000 × 20%). There is no phaseout of the Lifetime Learning Credit for the Kats because the
credit phaseout for married taxpayers filing jointly commences when modified AGI is $160,000 and ends at
$180,000.

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 SU 8: Tax Credits and Payments 7

Credits for Children and Dependents

3. There are four credits available for children and/or dependents.
a. Child and Dependent Care Credit
b. Child Tax Credit
c. Additional Child Tax Credit
d. Credit for Other Dependents
4. The Child and Dependent Care Credit is available for offsetting child and dependent
care expenses and is reported on Form 2441. The Child and Dependent Care Credit is
nonrefundable.
a. A taxpayer is eligible for this credit only if items b. and c. below are satisfied.
b. Employment. Child and dependent care expenses are incurred to enable the taxpayer to
be gainfully employed.
1) The expenses may be incurred when the claimant is employed or actively seeking
employment.
c. Household cost. The taxpayer provides more than half the cost of maintaining a
household for a dependent under age 13 or a physically or mentally incapacitated spouse
or dependent.
1) To be a qualifying person, the person must have lived with the taxpayer for more
than half of 2023.
2) Special rule for children of divorced or separated parents. Even if the taxpayer
cannot claim his or her child as a dependent, the child is treated as the taxpayer’s
qualifying person if
a) The child was under age 13 or was not physically or mentally able to care for
himself or herself and
b) The taxpayer was the child’s custodial parent.
i) The custodial parent is the parent with whom the child lived for the
greater number of nights in 2023. If the child was with the parent for
an equal number of nights, the custodial parent is the parent with the
higher adjusted gross income.

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8 SU 8: Tax Credits and Payments

3) Qualifying Employment Related Expenses

a) Household services, such as babysitting, housekeeping, and nursery.
b) Outside services, such as day care, must be in qualified facilities.
i) Outside expenses for the care of an incapacitated spouse or dependent
qualify only if the individual spends more than 8 hours a day in the
taxpayer’s home.
c) The cost of sending a child to school if the child is in a grade below
kindergarten.
d) Payments to a relative for the care of a qualifying individual.
i) These payments do not qualify for the credit if the taxpayer claims a
dependent exemption for the relative or if the relative is the taxpayer’s
child and is under age 19.
4) The cost of transporting a qualifying person from the home to the care location and
back is a nonqualified expense.
5) Total child and dependent care expenses cannot exceed the taxpayer’s earned
income. For married taxpayers, the income for this limitation is the smaller income
of the two.
a) If one of the spouses is a full-time student at an educational institution or is
unable to care for himself or herself, (s)he is considered to have earned $250
per month if there is one qualifying individual and $500 per month if there are
two or more qualifying individuals.
6) For 2023, child and dependent care expenses are limited to $3,000 for one qualifying
individual and $6,000 for two or more individuals, less excludable employer
dependent-care assistance program payments.
7) The credit is equal to 35% of the child and dependent care expenses paid during the
year.
a) This rate is reduced by 1% (but not below 20%) for each $2,000 (or part
thereof) by which AGI exceeds $15,000.
b) A taxpayer with AGI over $43,000 will have a credit of 20%.

EXAMPLE 8-5 Child and Dependent Care Credit

Kimberly is a head of household taxpayer with twin 2-year-old daughters. Kimberly has an AGI of $80,000.
Kimberly is eligible for a 20% credit on the first $6,000 of dependent care expenses. Kimberly spent $7,000
on childcare, allowing her to claim a $1,200 Dependent Care Credit ($6,000 × 20%).

d. Taxpayers must provide each dependent’s taxpayer identification number in order to

claim the credit, as well as the identifying number of the service provider.

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 SU 8: Tax Credits and Payments 9

e. The figure below is a general guide for determining if the taxpayer qualifies for the credit:

Figure 8-1
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10 SU 8: Tax Credits and Payments

Child Tax Credit, Additional Child Tax Credit, and Credit for Other Dependents
5. The Child Tax Credit (CTC) is for taxpayers who have a qualifying child. It is in addition to the
Child and Dependent Care Credit and the Earned Income Credit.
a. For 2023, the maximum credit is $2,000.
b. The CTC is not refundable.
6. The Additional Child Tax Credit (ACTC) is for certain individuals who get less than the full
amount of the CTC. This credit is refundable up to the lesser of 15% of earned income in
excess of $2,500 or the unclaimed portion of the nonrefundable credit. The refund is capped at
$1,600 per child.
7. The Credit for Other Dependents is a $500 nonrefundable credit for dependents other than a
qualifying child or for a qualifying child without the required SSN.
8. A qualifying child for purposes of the CTC is a child who
a. Is the taxpayer’s son, daughter, stepchild, foster child, brother, sister, stepbrother,
stepsister, half brother, half sister, or a descendant of any of them (for example, the
taxpayer’s grandchild, niece, or nephew);
b. Was under age 17 at the end of 2023;
c. Did not provide over half of his or her own support for 2023;
d. Lived with the taxpayer for more than half of 2023;
1) A child is considered to have lived with the taxpayer for more than half of 2023
a) If the child was born or died in 2023 and the taxpayer’s home was the child’s
home for more than half the time (s)he was alive during the year.
b) Temporary absences by the taxpayer or the child for special circumstances,
such as school, vacation, business, medical care, military service, or
detention in a juvenile facility, count as time the child lived with the taxpayer.
c) Exceptions exist for kidnapped children and children of divorced or separated
parents.
e. Is claimed as a dependent on the taxpayer’s return;
f. Does not file a joint return for the year (or files it only to claim a refund of withheld income
tax or estimated tax paid);
g. Was a U.S. citizen, a U.S. national, or a U.S. resident alien; and
h. Has a Social Security number (SSN) issued before the due date of the return.
NOTE: An adopted child is always treated as the taxpayer’s own child. An adopted child
includes a child lawfully placed with the taxpayer for legal adoption.

EXAMPLE 8-6 CTC Age Test

The taxpayer’s son turned 17 on December 30, 2023. He is a citizen of the United States, and the taxpayer
claimed him as a dependent on the taxpayer’s return. He is not a qualifying child for the CTC because he
was not under age 17 at the end of 2023.

EXAMPLE 8-7 CTC Citizenship Test

Your 10-year-old nephew lives in Mexico and qualifies as your dependent. Because he is not a U.S. citizen,
U.S. national, or U.S. resident alien, he is not a qualifying child for the CTC.

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 SU 8: Tax Credits and Payments 11

9. For 2023, the credit is phased out when AGI reaches $400,000 for married filing jointly and
$200,000 for all other taxpayers.
a. The credit is reduced by $50 for each $1,000 by which the taxpayer’s AGI exceeds the
threshold.
10. The credit is allowed only for tax years consisting of 12 months.
11. The credits are reported on Schedule 8812 reproduced below and on the next page.

Figure 8-2

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12 SU 8: Tax Credits and Payments

Figure 8-2 (continued)

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 SU 8: Tax Credits and Payments 13

Retirement Savings Contributions Credit (Saver’s Credit)

12. The Saver’s Credit can be taken for the taxpayer’s contributions to a traditional or Roth IRA,
401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18), or governmental 457(b) plan and for
voluntary after-tax employee contributions to qualified retirement and 403(b) plans.
13. Rollover contributions (money that the taxpayer moved from another retirement plan or IRA) are
not eligible for the Saver’s Credit. Additionally, eligible contributions may be reduced by any
recent distributions the taxpayer received from a retirement plan or IRA.
14. The taxpayer is eligible for the credit if the taxpayer is (a) age 18 or older, (b) not claimed as a
dependent on another person’s return, and (c) not a full-time student.
a. A taxpayer is a student if, during any part of 5 calendar months of 2023, the taxpayer was
1) Enrolled as a full-time student at a school
a) A school includes technical, trade, and mechanical schools. It does not include
on-the-job training courses, correspondence schools, or schools offering
courses only through the Internet.
2) Took a full-time, on-farm training course given by a school or a state, county, or local
government agency
15. The amount of the credit is 50%, 20%, or 10% of a maximum contribution amount of $2,000
($4,000 if married filing jointly) to the taxpayer’s retirement plan or IRA, based on the adjusted
gross income.
a. The chart below has the Saver’s Credit AGI limits for 2023.
2023 Saver’s Credit
Credit Rate Married Filing Jointly Head of Household All Other Filers
50% of contribution AGI ≤ $43,500 AGI ≤ $32,625 AGI ≤ $21,750
20% of contribution $43,501-$47,500 $32,626-$35,625 $21,751-$23,750
10% of contribution $47,501-$73,000 $35,626-$54,750 $23,751-$36,500
0% of contribution more than $73,000 more than $54,750 more than $36,500

EXAMPLE 8-8 Retirement Savings Contribution Credit

Stephanie, who works at a retail store, is married and earned $39,000 in 2023. Stephanie’s husband was
unemployed in 2023 and did not have any earnings. Stephanie contributed $1,000 to her IRA in 2023. After
deducting her IRA contribution, Stephanie’s adjusted gross income on her joint return is $38,000. Stephanie
may claim a 50% credit, $500, for her $1,000 IRA contribution.

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14 SU 8: Tax Credits and Payments

Credit for the Elderly or Disabled

16. The Credit for the Elderly or Disabled is nonrefundable.
a. An individual may be eligible for this credit if (s)he was age 65 before the close of the tax
year or retired before the close of the tax year due to a total and permanent disability.

Figure 8-3

b. The credit is equal to 15% times an initial base amount, which is $5,000 ($7,500 for
married filing joint return with both spouses age 65 or older, $3,750 MFS), and limited to
disability income if under age 65. This initial base amount is reduced by the following:
1) Tax-exempt Social Security benefits,
2) Pension or annuity benefits excluded from gross income,
3) Disability income if under 65, and
4) One-half the excess of AGI over $7,500 ($10,000 for married filing jointly,
$5,000 MFS).

EXAMPLE 8-9 Elderly Credit

Virginia is 66 and unmarried, claims the standard deduction, and has not started to receive any retirement
income. In 2023, Virginia’s AGI is $16,000 and her taxable income is $300 ($16,000 AGI – $13,850 standard
deduction – $1,850 additional standard deduction), creating a $30 ($300 × 10%) tax liability. Virginia’s
remaining base amount for the elderly credit is $750 {$5,000 – [($16,000 – $7,500) × 50%]}, creating a $113
credit ($750 × 15%). Virginia’s $30 tax liability is less than the $113 credit, so she can only claim $30 of the
credit.

c. A married person filing separately who lives with the spouse at any time during the year
may not claim the credit.
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 SU 8: Tax Credits and Payments 15

d. The credit is claimed/reported on Schedule R. The following table provides the initial credit
amounts:
Initial Amounts
THEN entered on line 10
IF the taxpayer’s filing status is . . . of Schedule R is . . .
single, head of household, or qualifying widow(er) with dependent child
and, by the end of 2023, the taxpayer was
• 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
• under 65 and retired on permanent and total disability . . . . . . . . . . . . . . . . . . . . . $5,000
married filing a joint return and by the end of 2023
• both spouses were 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,500
• both spouses were under 65 and one spouse retired on permanent and
total disability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
• both spouses were under 65 and both spouses retired on permanent and
total disability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,500
• one spouse was 65 or older, and the other was under 65 and retired on
permanent and total disability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,500
• one spouse was 65 or older, and the other was under 65 and not retired
on permanent and total disability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
married filing a separate return and the taxpayer did not live with the
taxpayer’s spouse at any time during the year and, by the end of 2023, the
taxpayer was
• 65 or older . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,750
• under 65 and retired on permanent and total disability . . . . . . . . . . . . . . . . . . . . . $3,750

THEN, even if the taxpayer qualifies,

the taxpayer CANNOT take credit if . . .
OR the total of the taxpayer’s nontaxable
The taxpayer’s adjusted Social Security and other nontaxable
IF the taxpayer’s gross income (AGI) is pension(s), annuities, or disability income
filing status is . . . equal to or more than . . . is equal to or more than . . .
single, head of household,
or qualifying widow(er) with $17,500 $5,000
dependent child
married filing jointly and only one
$20,000 $5,000
spouse qualifies
married filing jointly and both
$25,000 $7,500
spouses qualify
married filing separately and the
taxpayer lived apart from the $12,500 $3,750
taxpayer’s spouse for all of 2023

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16 SU 8: Tax Credits and Payments

Adoption Credit
17. A nonrefundable Adoption Credit is allowed for qualified adoption expenses.
a. An eligible child must be under 18 years of age or must be physically or mentally
incapable of self-care.
b. Qualified adoption expenses are reasonable and necessary adoption expenses, including
adoption fees, court costs, attorney fees, and other directly related expenses.
1) Expenses that are not eligible for the Adoption Credit include
a) Costs associated with a surrogate parenting arrangement,
b) Expenses incurred in violation of state or federal law,
c) Expenses incurred in connection with the adoption of a child of the taxpayer’s
spouse, and
d) Infant care supplies.

EXAMPLE 8-10 Adoption Credit

A taxpayer with modified AGI of $80,000 pays $15,000 of qualified adoption expenses to adopt a 10-year-old
girl. As part of the taxpayer’s employee benefit program, the employer reimburses the taxpayer for $5,000.
This amount reduces the taxpayer’s qualified adoption expenses to $10,000. Thus, the taxpayer can only
claim a $10,000 credit for qualified adoption expenses.

c. The maximum credit is $15,950 per qualified child, including a special-needs domestic
adoption.
1) The maximum credit amount is allowed for the adoption of a child with special
needs regardless of the actual expenses paid or incurred in the year the adoption
becomes final.
2) The amount of the credit allowable for any tax year is phased out for taxpayers
with modified adjusted gross income (MAGI) in excess of $239,230 and is fully
eliminated when MAGI reaches $279,230.

3) The credit is also reduced if the taxpayer receives excludable adoption assistance
from an employer.
d. Unused credit may be carried forward for up to 5 years and is not subject to the AGI
phaseout.
Residential Mortgage Interest Credit
18. The Residential Mortgage Interest Credit is nonrefundable.
a. State and local governments can elect to issue qualified mortgage bonds (QMBs) in lieu of
certain tax-exempt bonds.
1) The QMBs finance mortgage credit certificates (MCCs) issued to qualified individuals
who use the MCCs when privately financing their first purchase of a principal
residence.
2) The interest on the home mortgage is the base.
3) The MCC rate is between 10% and 50% (assumption is 25%).
4) If the rate exceeds 20%, the credit is limited to $2,000 per year.
5) MCC credit disallowed by the overall limit may be carried forward 3 years.

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 SU 8: Tax Credits and Payments 17

EXAMPLE 8-11 Residential Mortgage Interest Credit

David and Lydia paid $4,800 of interest in 2023 on the mortgage given upon acquiring their first home. They
received a mortgage credit certificate that specifies a 20% credit rate. They are entitled to a credit of $960
($4,800 × 20%). The amount of mortgage interest they may use as an itemized deduction is reduced by the
amount of the credit to $3,840 ($4,800 – $960).

Minimum Tax Credit (MTC)

19. The Minimum Tax Credit is nonrefundable.
a. A credit is allowed for alternative minimum tax (AMT) paid in a tax year against regular tax
liability in one or more subsequent tax years (Form 8801).
b. Individuals. The MTC amount is the AMT that would have been computed if the only
adjustments made to taxable income in computing AMTI were those for (tax-favored)
items that result in deferral, as opposed to exclusion, of income.
1) To compute the MTC amount, recompute the most recent year’s AMT without
adjustment for the following (exclusion) items, and add carryover MTC:
a) Standard deduction,
b) Tax-exempt interest on private activity bonds (except ones issued in 2009 or
2010),
c) Interest expense (e.g., investment interest),
d) Depletion, and
e) Taxes.
c. Limits. The MTC allowable is limited to current-year gross regular tax (reduced by certain
credits) minus current-year tentative minimum tax.
Gross regular tax
– Credits
– Tentative minimum tax (for current year)
= MTC maximum allowable

1) The current-year gross regular tax amount is reduced by the amount currently
allowable for each of the following:
a) Refundable credits
b) Nonrefundable personal credits
c) Foreign tax, drug testing, nonconventional source fuel credits
d) General Business Credit
d. Carryover. Any MTC amount beyond the current limit may be carried forward indefinitely.

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18 SU 8: Tax Credits and Payments

Earned Income Credit (EIC)

20. The Earned Income Credit is refundable.
a. Under Sec. 32(a), the EIC is available to individuals who have earned income and gross
income below certain thresholds.
1) An individual is not eligible for the EIC if (s)he does not include his or her correct
SSN on the return claiming the credit.
2) Individual taxpayer identification numbers (ITINs) disqualify the taxpayer and/or the
otherwise qualifying child (QC) from the credit.
3) Married individuals who file separately are not eligible for the EIC.
4) The EIC increases for individuals having at least one QC. Schedule EIC must be
attached to the return; it lists relevant information about each QC.
5) The credit is not available for taxpayers who fraudulently claim the EIC.
6) The IRS may request birth certificates, medical records, school records, etc., to
verify eligibility for the credit.
b. An individual without a QC must have his or her principal residence in the U.S. for more
than half of the tax year, be at least 25 but under age 65 at the end of the tax year, and
not be a dependent of another.
c. QC tests. In order for a child to be a QC, three tests must be met:
1) Relationship. The child must be related by birth or adoption or be an eligible foster
child or stepchild.
2) Residency. The child must have lived with the taxpayer in the United States for
more than half of the year.
3) Age. The child must be under age 19 at the close of the tax year, be permanently
disabled, or be a student under the age of 24.
d. Child claimed by both parents. In the event that two or more taxpayers claim the same
child in the same calendar year, the child will be the qualifying child for the parents first
and then for the taxpayer with the highest AGI.
1) If both of a qualifying child’s parents seek to claim the credit, but do not file jointly,
then the parent with whom the child resides the longest period of time during the
year may claim the child.
2) The parent with the highest AGI will be able to claim the child as a qualifying child
in the event the child spends an equal amount of time with each parent during the
year (Publication 504).
e. QC of another person. A taxpayer (or spouse if filing a joint return) who is a qualifying
child of another person cannot claim the EIC.
1) This applies even if the person for whom the taxpayer is the qualifying child does not
claim the EIC or meet the criteria in order to claim the EIC.

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 SU 8: Tax Credits and Payments 19

Figure 8-4

f. Earned income includes wages, salaries, tips, and net earnings from self-employment.
1) It does not include nontaxable compensation (e.g., military allowances), welfare
benefits (e.g., AFDC), veteran’s benefits, pensions, annuities, unemployment
compensation, and scholarships.
2) Disqualified income includes interest, dividends, capital gain net income, positive
passive income, nonbusiness rents, or royalties.
3) For 2023, the amount of disqualified income that causes a taxpayer to become
ineligible for the EIC is $11,000.

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20 SU 8: Tax Credits and Payments

g. Calculation of EIC. Multiply the individual’s earned income by the applicable percentage.

EIC: Maximum Amounts, 2023

Earned
Type of Applicable Income Maximum
Taxpayer Percentage Amount EIC
0 QC 7.65% $ 7,840 $ 600
1 QC 34.00% 11,750 3,995
2 QC 40.00% 16,510 6,604
3 or more QC 45.00% 16,510 7,430

h. Phaseout of EIC. Decrease the maximum EIC by any phaseout, which is determined
by multiplying the applicable phaseout percentage by the excess of the amount of the
individual’s AGI (or earned income, if greater) over the beginning amount.
1) No EIC is available when AGI or earned income exceeds the completed phaseout
amount.

EIC: Phaseout Amounts, 2023

Beginning Completed
Applicable Beginning Phaseout Completed Phaseout
Type of Phaseout Phaseout Amount for Phaseout Amount for
Taxpayer Percentage Amount Joint Filers Amount Joint Filers
0 QC 7.65% $ 9,800 $16,370 $17,640 $24,210
1 QC 15.98% 21,560 28,120 46,560 53,120
2 QC 21.06% 21,560 28,120 52,918 59,478
3 or more QC 21.06% 21,560 28,120 56,838 63,398

EXAMPLE 8-12 Earned Income Credit

Joe is a 50-year-old single taxpayer with wages of $12,940 and $9,000 of AGI. Joe does not have any
qualifying children and is eligible for the EIC. With no qualifying children, Joe’s applicable percentage for the
EIC is 7.65%. Joe’s earned income of $12,940 is greater than the amount required for the maximum credit
of $7,840. The higher of his earned income or AGI is $12,940, which is greater than the beginning phaseout
amount of $9,800. Therefore, Joe’s earned income credit is $360 {$600 – [($12,940 – $9,800) × 7.65%]}.

Due Diligence Requirement

i. Penalty. Section 6695(g) imposes a $600 penalty with respect to any return or claim for
refund for each failure to comply with the four due diligence requirements imposed by
regulations with respect to determining a taxpayer’s eligibility for the EIC or the amount of
any allowable EIC.
1) New expanded regulations clarify these requirements and set a performance
standard for the “knowledge” requirement (i.e., what a reasonable and well-
informed tax return preparer, knowledgeable in the law, would do). The four due
diligence requirements are discussed on the next page.

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 SU 8: Tax Credits and Payments 21

Completion of Form 8867

a) Complete Form 8867, Paid Preparer’s Due Diligence Checklist, truthfully and
accurately and any actions described on Form 8867 for applicable credit(s)
claimed.
i) Determine that this taxpayer is eligible to claim the EIC for the number
of children for whom the EIC is being claimed or to claim the EIC if the
taxpayer has no qualifying children.
ii) Determine that the child lived with the taxpayer for over half of the year.
iii) Explain the tiebreaker rules as described in item d. on page 18.
Computation of the Credit
b) Complete the applicable EIC worksheet associated with Form 1040, 1040-SS,
1040-PR, or 1040-NR or an equivalent and all related forms and schedules.
Knowledge
c) Interview the taxpayer, ask questions, and document the taxpayer’s responses
and review the information to determine that the taxpayer is eligible to claim
the credit.
i) Do not ignore the implications of information furnished or known.
ii) Make reasonable inquiries in such a manner that another well-informed
tax preparer would conclude that the information furnished appears to
be correct, consistent, and complete.
iii) Document any additional inquiries made and the client’s responses.
Record Retention
d) Satisfy the document retention requirement by retaining the following
five records:
i) Form 8867;
ii)The EIC worksheet(s) or the preparer’s own worksheet(s);
iii)
Copies of any taxpayer documents relied on to determine eligibility for or
amount of EIC;
iv) A record of how, when, and from whom the information used to prepare
the form and worksheet(s) was obtained; and
v) A record of any additional questions the preparer asked and the client’s
answers.
e) These records must be kept for 3 years from the latest of the following due
dates:
i) The due date of the tax return (not including extensions)
ii) The date the return was filed (if a signing tax return preparer
electronically filed the return)
iii) The date the return was presented to the taxpayer for signature (if the
signing tax preparer is not electronically filing the return)
iv) The date a preparer submitted the part of the return for which they were
responsible to the signing tax return preparer (if that preparer is a
nonsigning tax return preparer)
f) The retention of a copy of the Social Security cards of the taxpayer and each
qualifying child is not required.

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22 SU 8: Tax Credits and Payments

Residential Energy Credits

21. There are two credits available for individuals to improve the energy consumption of their
residence. The first is for installing alternative energy property, and the second is for installing
energy-efficient improvement property.
a. The residential clean energy credit (previously the residential energy efficient property
credit) for property placed in service in 2022 through 2032 is 30% of the cost of qualified
property, which includes the following:
1) Solar electric property
2) Solar water heating property
3) Small wind energy property
4) Geothermal heat pump property
5) Fuel cell property
6) Biomass fuel property
b. The energy efficient home improvement credit (previously the nonbusiness energy
property credit) is the sum of (1) 10% of the amount paid or incurred for qualified energy
efficiency improvements installed during the tax year and (2) the amount of residential
energy property expenditures.
c. The total maximum credit is $500 over the lifetime of the taxpayer. The maximum lifetime
credit is $200 for exterior windows and skylights.

10% Property Fixed Limit Property

Insulation Energy-efficient building property $300
Exterior doors Natural gas, propane, oil furnace,
Metal and asphalt roof hot water boiler $150
Exterior windows and skylights Advanced main air circulating fan $50

Premium Tax Credit (PTC)

22. Taxpayers who obtain health insurance coverage through the Health Insurance Marketplace
may be eligible for the Health Insurance Premium Tax Credit. The Premium Tax Credit is a
refundable credit.
a. Historically, the credit is available to households with income no greater than 400% of the
federal poverty line. However, for 2021 through 2025, this ceiling is removed.
23. The amount of the credit is generally equal to the premium for the second lowest cost silver plan
available through the marketplace minus a certain percentage of household income.
24. The cost of insurance is capped at 9.12% of household income. The percentage decreases as
income decreases.
25. Taxpayers may be eligible for the credit if they meet all of the following requirements:
a. Buy health insurance through the Marketplace for at least 1 month;
b. Are ineligible for coverage through an employer or government plan;
1
c. Do not file a separate return, if married ; and
d. Cannot be claimed as a dependent by another person.
1
There is an exception for MFS if the taxpayer is a victim of domestic violence.

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 SU 8: Tax Credits and Payments 23

26. The credit is not allowed for any period not lawfully present in the U.S.
27. Eligible taxpayers may either receive advance payments toward their health insurance premiums
or receive a regular credit at the end of the year.
28. Taxpayers who claim the Advanced Premium Tax Credit must file a tax return regardless of
whether the taxpayer’s income is below the filing threshold.
a. The return must include Form 8962, Premium Tax Credit (PTC), to compare the amount
the taxpayer received for the Advanced Premium Tax Credit to the amount the taxpayer
is actually eligible for based on the taxpayer’s actual income.
1) If the taxpayer earns more income than was used for determining the Advanced
Premium Tax Credit, the taxpayer may be required to repay some or all of the
excess credit received.
2) A taxpayer who does not complete the reconciliation will not be eligible for the
Advanced Premium Tax Credit in future years.
29. A refund is available for eligible taxpayers who did not receive any advance payments. All
taxpayers who received advanced payments must deduct the total of any advanced payments
received during the year from the amount of the premium tax credit calculated on the return.
This may affect the tax refund or balance due.
30. Taxpayers must claim the credit by filing a federal income tax return regardless of which method
is used to receive the tax credit.
31. Taxpayers with insurance coverage will receive one of three tax forms showing their insurance
coverage status. All Forms 1095 show information about the coverage, who is included in the
coverage, and for what months the coverage was applied.
a. Form 1095-A, Health Insurance Marketplace Statement, is received by individuals who
purchased health insurance through a state or federal health insurance marketplace.
b. Form 1095-B, Health Coverage, is received by individuals from their health insurance
provider (e.g., a health insurance company).
c. Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, is received by
certain employees with information about what coverage the employer offered.
d. Only taxpayers who receive health insurance through a state or federal health insurance
marketplace are required to wait to file until they receive Form 1095-A, as this impacts
the calculation of the premium tax credits.
e. Taxpayers who expect to receive Form 1095-B or 1095-C may file their federal income tax
return before their form is received by confirming how many months they were covered
by qualifying health insurance.
f. Taxpayers should store these forms like any other tax document for recordkeeping
purposes.
g. Taxpayers can receive multiple Forms 1095 if their health insurance coverage changed
during the year.

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24 SU 8: Tax Credits and Payments

Clean Vehicle Credit

32. Beginning January 1, 2023, eligible clean vehicles (formerly known as electric vehicles) may
qualify for a tax credit of up to $7,500.
a. The amount of the credit depends on when the eligible new clean vehicle is placed in
service and whether the vehicle meets certain requirements for a full or partial credit. The
buyer must meet certain income limitations.
b. Consumers are also eligible for a tax credit for used or previously owned clean vehicles.
The clean vehicle cannot exceed certain price amounts. The credit equals the lesser of
$4,000 or 30% of the vehicle’s sale price.

8.2 PAYMENTS
Estimated Tax Payments
1. The IRC is structured to obtain at least 90% of the final income tax through withholding and
estimated tax payments. Individuals who earn income not subject to withholding must pay
estimated tax on that income in quarterly installments.
a. Calendar-year due dates. For a calendar-year taxpayer, the installments are due by
1) April 15 (January-March),
2) June 15 (April-May),
3) September 15 (June-August), and
4) January 15 (September-December) of the following year.
NOTE: Dates are adjusted for weekends and holidays.
b. Underpayment of the fourth installment does not result in penalty if, on or before
January 31 of the following tax year, an individual both files a return and pays the amount
computed payable on that return.
1) Any underpayment penalties from the first three quarterly installments will not
increase any further.
c. Each of the following is treated as payment of estimated tax:
1) The election to apply an overpayment of tax in a prior tax year, which has not been
refunded, to the following year’s tax return
a) It is applied to the first required installment due.
2) Amount of federal income tax (FIT) withheld (by an employer) from wages
a) The aggregate amount is treated as if an equal part was paid on each due
date, unless the individual establishes the actual payment dates.
3) Direct payment by the individual (or another on his or her behalf)
a) It is applied to the first estimated tax payment due.
4) Excess FICA withheld when an employee has two or more employers during a tax
year who withheld (in the aggregate) more than the ceiling on FICA taxes
5) Refundable tax credits

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 SU 8: Tax Credits and Payments 25

d. Installment percentage. Each installment must be 25% of the lowest of the following
amounts:
1) 100% of the prior year’s tax (if a return was filed)
2) 90% of the current year’s tax
3) 90% of the annualized current year’s tax (applies when income is uneven)
e. Safe harbor rule. Taxpayers whose 2022 tax returns showed AGI in excess of $150,000
($75,000 for married filing separately) must apply the safe harbor rule. This rule requires
the taxpayer to make estimated payments of the lesser of 110% of the 2022 tax liability or
90% of the 2023 tax liability.
f. A taxpayer is not required to make a payment until the first period in which there is
income.

EXAMPLE 8-13 Estimated Tax Payments

John’s tax liability for 2022 was $10,000 and his AGI was $100,000. John projects his tax liability for 2023 to
be $12,000. In order to avoid an underpayment of estimated tax penalty, John must pay through withholdings
and estimated payments throughout the year, i.e., the lesser of $10,000 (100% of prior year tax, the 110% is
not applied because John’s prior year AGI is less than $150,000) or $10,800 (90% of the current year tax).

g. Tax refers to the sum of the regular tax, AMT, self-employment tax, and household
employee tax.
h. Penalty. A penalty is imposed if, by the quarterly payment date, the total of estimated tax
payments and income tax withheld is less than 25% of the required minimum payment for
the year.
1) The penalty is determined each quarter.
2) The penalty is the federal short-term rate plus 3% times the underpayment.
3) The penalty is not allowed as an interest deduction.
i. The penalty will not be imposed if any of the following apply:
1) Actual tax liability shown on the return for the tax year (after reduction for amounts
withheld by employers) is less than $1,000.

EXAMPLE 8-14 Underpayment Penalty

Taxpayer has a tax liability of $11,000 for 2023. Taxpayer’s employer withheld $7,000 for 2023. Taxpayer’s
2022 liability was $7,000 and AGI was $160,000.
Even though only $700 [($7,000 prior year liability × 110%) – $7,000 current year withholding] is subject to
the penalty, the $1,000 minimum exception does not apply due to the fact that the exception is based on
the current year. The total tax liability shown on the tax return of $11,000 minus the amount paid through
withholding of $7,000 is greater than $1,000. Hence, the taxpayer will be subject to an underpayment
penalty.

2) No tax liability was incurred in the prior tax year.

3) The IRS waives it for reasonable cause shown.

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26 SU 8: Tax Credits and Payments

j. Farmers or fishermen who expect to receive at least two-thirds of their gross income
from farming or fishing activities (or did in the prior tax year) may pay estimated tax in
one installment.
1) For 2023, the installment can be made as late as January 16, 2024, without penalty.
The installment must be for the entire amount of estimated tax.
2) Alternatively, the farmer or fisherman does not need to make an installment payment
if (s)he files his or her tax return for 2023 and pays the entire amount due by
March 1, 2024.
3) Wages received as a farm employee are not farm income.
4) S corporation distributions from farming are farm income to the shareholder.
k. To avoid underpayment penalties, taxpayers may review their withholding and estimated
tax payment situation throughout the year. A mid-year review allows the taxpayer to look
back at the recently filed prior-year return and know if too much or too little was withheld
last year.
1) Any need for correction can be accomplished by having an employer adjust the
amount being withheld for the rest of the year or by the taxpayer calculating any
deficiency and making appropriate estimated quarterly payments. Items taxpayers
should consider include life events (e.g., marriages and births) and financial
changes (e.g., a raise or bonus, change in employment, or a significant capital gain
from the sale of property).
l. The following chart explains in general who is and is not subject to estimated payments:

Figure 8-5

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 SU 8: Tax Credits and Payments 27

Exemption from Withholding on Form W-4

2. Some taxpayers are exempt from withholding requirements. The following chart explains the
exemptions:

Figure 8-6

NOTE: This chart does not apply if the taxpayers are 65 or older or blind or if the taxpayers will
itemize deductions or claim tax credits.

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28 SU 8: Tax Credits and Payments

Excess Social Security Credit

3. An employer must deduct and withhold Social Security tax on an employee’s first $160,200 of
wages. For 2023, the withholding rate is 6.2%.
a. When the maximum withholding is exceeded due to the correct withholding of two or more
employers, a special refund of the excess amount may be obtained only by claiming a
credit for the amount.
1) The credit must be claimed in the same manner as if such special refund were an
amount deducted and withheld as income tax at the source.
2) The credit is computed separately for each spouse on a joint return.
b. When an employer incorrectly withholds Social Security taxes on more than the maximum
amount, a credit may not be claimed for the excess.
1) The employer should refund the overcollection to the employee.
Claims for Refund
4. Taxpayers have a limited amount of time in which to file a claim for a credit or refund. Taxpayers
encountering trouble obtaining a refund or other tax issues may request assistance from the
Taxpayer Advocate Service by submitting Form 911.
a. Form 1040-X. Taxpayers file a claim for refund on Form 1040-X with the Internal Revenue
Service Center where the original return was filed.
1) A separate form for each year or period involved is filed.
2) An explanation of each item of income, deduction, or credit on which the refund
claim is based is included.
b. Statute of limitations. Generally, taxpayers must file a claim for credit or refund within
3 years from the date the return was filed or 2 years from the date the tax was paid,
whichever is later.
1) The Tax Court can consider taxes paid during the 3-year period preceding the date
of a notice of deficiency for determining any refund due to a nonfiler.
2) If a claim is made within 3 years after the filing of the return, the credit or refund
cannot be more than the part of the tax paid within the 3 years (plus the length of
any extension of time granted for filing the return) before the claim was filed.
a) If a claim is filed after the 3-year period but within the 2 years from the time a
tax was paid, the credit or refund cannot be more than the tax paid within the
2 years immediately before the filed claim.
3) The period of limitations on credits and refunds can be suspended for individuals
during periods in which they are unable to manage their financial affairs because of
physical or mental impairment that is medically determinable and either
a) Has lasted or can be expected to last continuously for at least 12 months or
b) Can be expected to result in death.

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