CPA REG: Guide to Major Tax Credits

Tax Credits for the CPA REG Exam

Tax credits directly reduce tax liability dollar for dollar, making them more valuable than deductions of equal amount. The REG exam tests knowledge of both individual and business credits, including eligibility requirements, computation, and refundability. Credits are classified as refundable (the taxpayer receives the excess as a refund) or nonrefundable (limited to the tax liability).

Child Tax Credit (IRC Section 24)

The child tax credit provides a credit for each qualifying child under age 17 at the end of the tax year. The child must be a U.S. citizen, national, or resident alien, must have a valid Social Security number, and must be claimed as a dependent on the taxpayer's return. Under the TCJA, the credit is $2,000 per qualifying child, with up to $1,600 refundable as the additional child tax credit. The credit phases out by $50 for every $1,000 of modified AGI exceeding $200,000 ($400,000 for MFJ).

A $500 nonrefundable credit is available for other qualifying dependents who do not qualify for the child tax credit, such as dependents age 17 or older or dependent parents. This credit is also subject to the same phase-out thresholds.

Earned Income Credit (IRC Section 32)

The earned income credit (EIC) is a refundable credit for low-to-moderate-income workers. The credit amount depends on earned income, filing status, and the number of qualifying children. The credit increases with earned income up to a maximum, remains at the maximum over a plateau range, and then phases out at higher income levels. Investment income must not exceed a specified threshold (adjusted annually for inflation).

Qualifying children must meet the relationship, age, residency, and joint return tests. Workers without qualifying children may still claim a smaller EIC if they are between ages 25 and 64. The credit cannot be claimed by MFS filers, by individuals who are qualifying children of other taxpayers, or by individuals without valid Social Security numbers.

Education Credits (IRC Section 25A)

Two education credits are available. The American Opportunity Tax Credit (AOTC) provides up to $2,500 per student for the first four years of postsecondary education. It is computed as 100% of the first $2,000 and 25% of the next $2,000 of qualified tuition and related expenses. Forty percent of the AOTC ($1,000 maximum) is refundable. The student must be enrolled at least half-time and pursuing a degree, and must not have completed the first four years of postsecondary education. The AOTC phases out at higher income levels.

The Lifetime Learning Credit (LLC) provides up to $2,000 per return (not per student) for qualified tuition and fees for any course at an eligible institution. There is no enrollment, degree, or year limitation. The LLC is nonrefundable and phases out at higher income levels. A taxpayer cannot claim both credits for the same student in the same year.

Child and Dependent Care Credit (IRC Section 21)

This nonrefundable credit is for expenses paid for the care of a qualifying individual (a dependent child under age 13 or a disabled dependent or spouse) to enable the taxpayer to work or look for work. The maximum qualifying expenses are $3,000 for one qualifying individual and $6,000 for two or more. The credit percentage ranges from 20% to 35% of qualifying expenses, depending on AGI. Both spouses must have earned income (or one must be a full-time student or disabled).

Adoption Credit (IRC Section 23)

The adoption credit is a nonrefundable credit for qualified adoption expenses, including court costs, attorney fees, and travel expenses. The maximum credit is adjusted annually for inflation. For special needs adoptions, the full credit amount is available regardless of actual expenses. The credit phases out at higher income levels. Any unused credit may be carried forward for up to five years.

General Business Credit (IRC Section 38)

The general business credit is an umbrella credit composed of numerous individual business credits, including the investment credit (including the rehabilitation credit and the energy credit), the work opportunity tax credit (WOTC), the research and development credit (IRC Section 41), the disabled access credit, the small employer health insurance credit, and the employer-provided child care credit.

The general business credit is limited to the excess of the taxpayer's net income tax over the greater of the tentative minimum tax or 25% of net regular tax liability exceeding $25,000. Unused credits may be carried back one year and carried forward 20 years. The WOTC provides a credit for wages paid to targeted group employees, generally equal to 40% of the first $6,000 of wages for employees who work at least 400 hours.

Foreign Tax Credit (IRC Section 901)

The foreign tax credit allows U.S. taxpayers to credit foreign income taxes paid or accrued against their U.S. tax liability, subject to the foreign tax credit limitation. The limitation ensures the credit does not exceed the U.S. tax attributable to foreign source income. The formula is: U.S. tax x (foreign source taxable income / worldwide taxable income). Excess credits may be carried back one year and forward 10 years. Taxpayers may alternatively deduct foreign taxes as an itemized deduction.

Exam Strategy

Know which credits are refundable (EIC, 40% of AOTC, additional child tax credit) versus nonrefundable
The child tax credit phases out at $200,000 single / $400,000 MFJ
AOTC is per student; LLC is per return
The general business credit limitation involves tentative minimum tax
Foreign tax credit is limited to U.S. tax on foreign source income
Credits are generally more beneficial than deductions of equal amount