What Is Tax Credit? A Basic Guide To Tax Credits 

Many people know that tax credits can help lower the amount of tax money you owe to the IRS. 

But what exactly are tax credits? How do they work? 

Let’s scroll down to find out!

What is a tax credit? 

A tax credit is a dollar-for-dollar reduction in a taxpayer’s final tax bill.

Generally, a tax credit is created to promote or reward certain kinds of conduct that the government deems advantageous to the economy, the environment, or any other essential goal. For instance, you can claim a tax credit if you install solar panels for home use to save energy and protect the environment. 

How does a tax credit work? 

As previously mentioned, a tax credit lowers the income tax you owe dollar-for-dollar. What does that really mean? Well, take a look at this example: 

Suppose that you have to pay $2000 taxes and have a $2000 tax credit—that means your tax will be subtracted to zero, and you will be totally tax-free!

This is also what makes a tax credit different from a tax deduction. A $2000 tax deduction only lowers your taxable income (the amount of income on which you owe taxes), not your final tax bill, by $2,000. So, if you fall into the 22% tax bracket, a $2,000 deduction would save you $440.

What are the different types of tax credits? 

There are three types of tax credits: nonrefundable, refundable, and partially refundable. Below are brief explanations of each tax credit category:

1. Refundable tax credits

As the name suggests, you may get a refund from the IRS with refundable tax credits. For instance, if you have $2000 tax due and a $3000 refundable tax credit, you would receive a $1000 refund. 

The most popular refundable tax credit is probably the earned income tax credit (EITC). The EITC is a tax credit for low- to moderate-income workers who meet specific requirements regarding family size, filing status, and income.

2. Nonrefundable tax credits

A nonrefundable credit refers to a credit that can only be used to reduce your taxes maximum to $0. It can’t go any lower than that to create a negative tax liability, in which case you’ll get a refund. So, if you’re eligible for a $1000 nonrefundable tax credit, and the tax you owe is only $600—the $400 excess is nonrefundable. Some frequently claimed nonrefundable tax credits are lifetime learning credit (LLC), foreign tax credit (FTC), general business credit (GBC), etc. 

3. Partially refundable tax credits 

Partially refundable tax credits only reduce a certain amount of your taxes and leave the remaining nonrefundable. The American Opportunity credit, for example, is a partially refundable tax credit that allows you to pay up to 40% of the credit as a tax payment. If you calculate a $1,000 American Opportunity credit, you can claim up to $400 as a refundable tax credit and the rest as a nonrefundable credit.

Want to know more about finance? 

If you’d like to explore more entrepreneurship stories, get simple explanations of complex financial terms, or learn about the best productivity tools, find more posts like this on the Shoeboxed blog.

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How to Determine Your Corporate Income Tax Liability

If you’re working as an employee in the US, filing your annual tax return is usually a simple process of reviewing the tax tables for the year and calculating your income tax on Form 1040. However, tax filing is a little more complicated for those who are self-employed or run a corporation. In this article, we’ll help you determine your corporate income tax liability based on your business entity type. Let’s dive in!

What is tax liability?

Tax liability is the amount of money you owe to the US government based on the current income of your business. Only C corporations are subject to paying corporate income taxes. 

On the other hand, if your business structure is a sole proprietorship, partnership, S corporation, or LLC, you’ll be subject to pass-through taxation, which means that any profits earned will be taxed on your personal tax return.

How to determine your corporate income tax liability

If your business is a C-corp, you’ll need to pay your taxes at a federal corporate tax rate, which is a flat 21%, plus your state tax rate, which varies by state.

According to the US tax system, C corporations pay their taxes twice: at the corporate level and then again at the shareholders level when they receive the profits as dividends. For example, if a C corporation distributed all or part of its $1 million in profit to shareholders, they will be taxed on it again when they file their individual tax returns.

One way for C-corps to avoid this double taxation is to incorporate as an S-corp instead of a C-corp. S corporations are flow-through entities, meaning profits and losses flow through the business to owners and shareholders. By that, S corporations don’t have to pay the corporate income tax liability. However, there are certain drawbacks in the S corporation status that may exceed the tax savings. You can discuss choosing your business type with a tax professional or a certified public accountant. 

If your business is not a C-corp, you should calculate and keep track of your business tax liability quarterly based on your annual taxable income. Estimating your business tax liability on a regular basis enables you to make quarterly payments to the IRS, avoiding facing a big tax bill at the end of the fiscal year. If you’re not sure how to calculate your corporate tax, check our guides on filing taxes as a corporation and an independent contractor: 

Bonus: Other types of tax liabilities 

Corporate income tax liability is just one of several tax liabilities your business may have. There are a couple of other tax liabilities to consider, such as the following.

Self-employment tax 

If you work as a sole proprietor, you must file Schedule C for your business. This means you’ll need to pay self-employment tax. In most cases, the self-employment tax liability is calculated at the same time as your tax return. Self-employment tax liability is included in your tax bill by multiplying your estimated taxable income by 15.3 %.

Don’t forget that half of your self-employment tax is deductible! For example, if you have $50,000 in taxable income per year, your self-employment tax is $7,650. However, half of that, or $3,825, would be fully deductible.

Sales tax 

If you sell products in your business’s jurisdiction, you’re responsible for paying sales tax. Similar to employee income tax withholding, sales tax should be collected from customers at the time of purchase. It’s recorded as a liability at the same time, and the amount is offset by the sales tax you charge and collect from your customers.

Payroll tax 

Payroll tax includes the income tax you withhold from staff paychecks, along with the employer portion of Federal Insurance Contributions (FICA) and any state and federal unemployment taxes.

The bottom line

Understanding your corporate income tax liability helps you control your financial situation, manage your budget properly, stay on top of your business expenses and deductions, and make more accurate decisions. If you’d like to explore more helpful accounting knowledge, tax preparation tips, and engaging success stories, we encourage you to subscribe to the Shoeboxed blog

Shoeboxed is an online application that can transform your receipts and documents into digital in just a click. Then, it automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes. 
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