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Tax credit

A tax credit is a sum deducted from the total amount a taxpayer owes to the state. A tax credit may be granted for various types of taxes, such as an income tax, property tax, or VAT. It may be granted in recognition of taxes already paid, as a subsidy, or to encourage investment or other behaviors. In some systems tax credits are 'refundable'[1] to the extent they exceed the relevant tax. Tax systems may grant tax credits to businesses or individuals, and such grants vary by type of credit.

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Credit for payments

Many systems refer to taxes paid indirectly, such as taxes withheld by payers of income, as credits rather than prepayments. In such cases, the tax credit is invariably refundable. The most common forms of such amounts are payroll withholding of income tax or PAYE, withholding of tax at source on payments to nonresidents, and input credits for value added tax.

Some systems treat payments of certain taxes as refundable payments of other taxes in specific cases. An example is the U.S. credit for Federal highway use tax paid with respect to gasoline or diesel fuel for vehicle use off highways, which may be claimed as a payment of on federal income tax returns.

Individual income tax credits

Income tax systems often grant a variety of credits to individuals. These typically include credits available to all taxpayers as well as tax credits unique to individuals. Some credits may be offered for a single year only.

Low income subsidies

Several income tax systems provide income subsidies to lower income individuals by way of credit. These credits may be based on income, family status, work status, or other factors. Often such credits are refundable when total credits exceed tax liability.

United Kingdom

In the United Kingdom, the 'child tax credit and working tax credit are paid directly into the claimant's bank account or Post Office Card Account - in exceptional circumstances these can be paid by giro however payments may stop if account details are not provided [2]. A minimum level of child tax credits is payable to all individuals or couples with children, up to a certain income limit. The actual amount of child tax credits that a person may receive depends on these factors: the level of their income, the number of children they have, whether the children are receiving Disability Living Allowance and the education status of any children over 16. Working tax credit is paid to single low earners with or without children who are aged 25 or over and are working over 30 hours per week and also to couples without children, at least one of whom is over 25, provided that at least one of them is working for 30 hours a week. If the claimant has children however, they may claim working tax credit from age 16 upward - provided that they are working at least 16 hours per week. [3]

United States

The U.S. system grants the following low income tax credits:

  • Earned income credit: this refundable credit is granted for a percentage of income earned by a low income individual. The credit is calculated and capped based on the number of qualifying children, if any. This credit is indexed for inflation and phased out for incomes above a certain amount. For 2009, the maximum credit was $5,657.
  • Credit for the elderly and disabled: A nonrefundable credit up to $1,125
  • Retirement savings credit: a nonrefundable credit of up to 50% of contributions to IRAs or similar plans, phased out at incomes above $16,000 ($24,000 for head of household and $32,000 for joint returns).
  • Mortgage interest credit: a nonrefundable credit that may be limited to $2,000, granted under specific mortgage programs.

Family relief

Some systems grant tax credits for families with children. These credits may be on a per child basis or as a credit for child care expenses.

The U.S. system offers the following nonrefundable family related income tax credits (in addition to a tax deduction for each dependent child):

  • child credit: a credit up to $1,000 per qualifying child.
  • Child and dependent care credit: a credit up to $6,000, phased out at incomes above $15,000.
  • Credit for adoption expenses: a credit up to $10,000, phased out at higher incomes.

Education, energy and other subsidies

Some systems indirectly subsidize education and similar expenses through tax credits.

The U.S. system has the following nonrefundable credits:

  • Two mutually exclusive credits for qualified tuition and related expenses. The American Opportunity Tax Credit is 100% of the first $2,000 and 25% of the next $4000 of qualified tuition expenses per year for up to two years. The Lifetime Learning Credit[4] is 20% of the first $10,000 of cumulative expenses. These credits are phased out at incomes above $50,000 ($100,000 for joint returns) in 2009. Expenses for which a credit is claimed are not eligible for tax deduction.
  • First time homebuyers credit up to $7,500.
  • Credits for purchase of certain nonbusiness energy property and residential energy efficiency. Several credits apply with differing rules.[5]

Business tax credits

Many systems offer various incentives for businesses to make investments in property or operate in particular areas. Credits may be offered against income or property taxes, and are generally nonrefundable to the extent they exceed taxes otherwise due. The credits may be offered to individuals as well as entities. The nature of the credits available varies highly by jurisdiction.

United States

U.S. income tax has numerous nonrefundable business credits. In most cases, any amount of these credits in excess of current year tax may be carried forward to offset future taxes, with limitations. The credits include the following, available to individuals and businesses:

  • Alternative motor vehicle credit: several credits are available for purchase of varying types of non-gasoline powered vehicles.[6]
  • Alternative fuel credits: a credit based on the amount of production of certain non-petroleum fuels.[7]
  • Disaster relief credits[8]
  • Credits for employing individuals in certain areas or those formerly on welfare or in targeted groups
  • Credit for increasing research expenses
  • A variety of industry specific credits

Many sub-Federal jurisdictions (states, counties, cities, etc.) within the U.S. offer income or property tax credits for particular activities or expenditures. Examples include credits similar to the Federal research and employment credits, property tax credits granted by cities (often called abatements) for building facilities within the city, etc. These items often are negotiated between a business and a governmental body, and specific to a particular business and property.

Federal nonrefundable investment tax credits

Tax credits, while they come in many forms, are authorized incentives under the Internal Revenue Code (and some state tax codes) to implement public policy. Congress, in an effort to encourage the private sector to provide a public benefit, allows a participating taxpayer a dollar for dollar reduction of their tax liability for investments in projects that probably would not occur but for the credits.

Federal Historic Rehabilitation Tax Credit

The legislative incentive program to encourage the preservation of historical buildings . Congress instituted a two-tier Tax Credit incentive under the 1986 Tax Reform Act. A 20% credit is available for the rehabilitation of historical buildings and a 10% credit is available for non-historic buildings, which were first placed in service before 1936. Benefits are derived from tax credits in the year the property is placed in service, cash flow over 6 years and repurchase options in year six.[9]

Renewable Energy/Investment Tax Credit (ITC)

This investment tax credit varies depending on the type of renewable energy project; solar, fuel cells ($1500/0.5 kW) and small wind (< 100 kW) are eligible for credit of 30% of the cost of development, with no maximum credit limit; there is a 10% credit for geothermal, microturbines (< 2 MW) and combined heat and power plants (< 50 MW). The ITC is generated at the time the qualifying facility is placed in service. Benefits are derived from the ITC, accelerated depreciation, and cash flow over a 6-8 year period.

Renewable Energy/Production Tax Credit (PTC)

Under present law, an income tax credit of 2.2 cents/kilowatt-hour is allowed for the production of electricity from utility-scale wind turbines, geothermal, solar, hydropower, biomass and marine and hydrokinetic renewable energy plants. This incentive, the renewable energy Production Tax Credit (PTC), was created under the Energy Policy Act of 1992 (at the value of 1.5 cents/kilowatt-hour, which has since been adjusted annually for inflation).[10]

Low Income (Affordable) Housing Tax Credit (LIHTC)

Under this program, created in the 1986 Tax Reform Act, the U.S. Treasury Department allocates tax credits to each state based on that states population. These credits are then awarded to developers who, together with an equity partner, develop and maintain apartments as affordable units. Benefits are derived primarily from the tax credits over a 10 year period.

Qualified School Construction Bond (QSCB)

QSCBs are U.S. debt instruments used to help schools borrow at nominal rates for the rehabilitation, repair and equipping of their facilities, as well as the purchase of land upon which a public school will be built. A QSCB holder receives a Federal tax credit in lieu of an interest payment. The tax credits may be stripped from QSCB bonds and sold separately. QSCBs were created by Section 1521 of the American Recovery and Reinvestment Act of 2009. Internal Revenue Code Section 54F also addresses QSCBs.

Work Opportunity Tax Credit (WOTC)

The Work Opportunity Tax Credit (WOTC) is a federal tax credit providing incentives to employers for hiring groups facing high rates of unemployment, such as veterans, youths and others. WOTC helps these targeted groups obtain employment so they are able to gain the skills and experience necessary to obtain better future job opportunities. The WOTC is based on the number of hours an employee works and benefits the employer directly. Foss and Company has been successful in developing a structure whereby passive third-party investors may take the tax credit benefit.

State tax credits

Approximately 43 states provide a variety of special incentive programs that utilize state tax credits. These include Brownfield credits, Film Production credits, Renewable energy credits, Historic Preservation credits and others. The amount of credit, the term of credit and the cost of the credit differs from state to state. These credits can be either in the form of a certificate, which can be purchased as an asset, or in a more traditional pass through entity. The tax credits can generally be used against insurance company premium tax, bank tax and income tax.

Value added tax

Resellers or producers of goods or providers of services (collectively, providers) must collect value added tax (VAT) in some jurisdictions upon billing or being paid by customers. Where these providers use goods or services provided by others, they may have paid VAT to other providers. Most VAT systems allow the amount of such VAT paid or considered paid to be used to offset VAT payments due, generally referred to as an input credit. Some systems allow the excess of input credits over VAT obligations to be refunded after a period of time.

Foreign tax credit

Income tax systems that impose tax on residents on their worldwide income tend to grant a foreign tax credit for foreign income taxes paid on the same income. The credit often is limited based on the amount of foreign income. The credit may be granted under domestic law and/or tax treaty. The credit is generally granted to individuals and entities, and is generally nonrefundable. See Foreign tax credit for more comprehensive information on this complex subject.

Credits for alternative tax bases

Several tax systems impose a regular income tax and, where higher, an alternative tax. The U.S. imposes an alternative minimum tax based on an alternative measure of taxable income. Mexico imposes an IETU based on an alternative measure of taxable income. Italy imposes an alternative tax based on assets. In each case, where the alternative tax is higher than the regular tax, a credit is allowed against future regular tax for the excess. The credit is usually limited in a manner that prevents circularity in the calculation.

References

External links

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