Federal tax incentives are credits, deductions, and exemptions written into the Internal Revenue Code that lower what you owe the IRS when you meet specific eligibility rules. For tax year 2026, several dollar amounts shifted and a group of energy-related credits disappeared entirely under the One Big Beautiful Bill Act, signed into law on July 4, 2025. What follows is what still exists, what you qualify for, what documentation you need, and how to claim it correctly.
Credits, Deductions, and Exemptions Are Not the Same Thing
A tax credit reduces your tax bill dollar for dollar. Owe $5,000, claim a $1,000 credit, pay $4,000. The savings don’t depend on your tax bracket, which is why credits are the most valuable category.
A deduction reduces your taxable income, not your tax. A $5,000 deduction saves someone in the 22% bracket $1,100, and someone in the 12% bracket $600. An exemption excludes certain income from taxation entirely, so it never enters the calculation.
Refundable vs. Nonrefundable: Why It Matters
A nonrefundable credit can zero out your tax liability but not go below it. If you owe $800 and have a $1,200 nonrefundable credit, you use $800 of it and lose the remaining $400. A refundable credit pays you the difference as a refund. That same $1,200 refundable credit on an $800 bill would leave you with $400 in your pocket.1Internal Revenue Service. Tax Credits for Individuals: What They Mean and How They Can Help Refunds
Some credits are partially refundable. The Child Tax Credit is one: part of it can generate a refund even when you owe no tax, but not all of it. Before claiming any credit, check which category it falls into, because that determines what you actually see.
Credits for Individuals and Families
Earned Income Tax Credit
The EITC is the largest refundable credit available to low- and moderate-income workers, and it scales with family size. For tax year 2026, the maximum amounts are:2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
- $8,231 with three or more qualifying children
- $7,316 with two children
- $4,427 with one child
- $664 with no qualifying children
Eligibility turns on your earned income, adjusted gross income, filing status, and whether any qualifying children meet age, relationship, and residency tests.3Internal Revenue Service. Who Qualifies for the Earned Income Tax Credit (EITC) Investment income above an annual threshold disqualifies you. Because the credit is fully refundable, workers whose income is too low to owe federal taxes still receive the full amount as a refund. It also draws heavy IRS scrutiny, which the penalties section covers.
Child Tax Credit
The One Big Beautiful Bill Act raised the Child Tax Credit from $2,000 to $2,200 per qualifying child starting in 2025, with inflation indexing from 2026. Up to $1,700 per child is refundable through the Additional Child Tax Credit, so families with little or no federal tax liability can still receive that portion.4Internal Revenue Service. Child Tax Credit
Each child must be under 17 at year-end, have a valid Social Security number, live with you more than half the year, and be claimed as a dependent. The full credit is available at adjusted gross income up to $200,000 single or $400,000 joint, and phases out by $50 for every $1,000 above those thresholds.4Internal Revenue Service. Child Tax Credit
American Opportunity Tax Credit
The AOTC covers qualified education expenses during the first four years of higher education. It equals 100% of the first $2,000 in tuition and required fees, plus 25% of the next $2,000, for a maximum of $2,500 per eligible student per year. Forty percent of the credit, up to $1,000, is refundable.5Internal Revenue Service. American Opportunity Tax Credit
You can claim the full credit at modified adjusted gross income of $80,000 or less ($160,000 joint), and it phases out completely at $90,000 single ($180,000 joint). You need Form 1098-T from the school, and you report the credit on Form 8863 with your return.
Credits and Deductions for Businesses
Research and Development Credit
Businesses that invest in developing new or improved products, processes, or software may qualify for the R&D credit under IRC Section 41. The qualifying activity must pass a four-part test: the expenses must be eligible under Section 174, the research must aim to discover technological information, the findings must go toward a new or improved business component, and substantially all of the activity must involve a process of experimentation. All four tests apply to each component you claim.6Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities – Qualified Research Activities
The credit is not limited to high-tech or pharmaceutical firms. Manufacturers improving a production process, software developers building new features, and engineering firms solving design problems can all qualify if they document the experimentation. Substantiation requires payroll data, employee time tracking, project descriptions, and supply expenses tied to specific research activities.7Internal Revenue Service. Audit Techniques Guide: Credit for Increasing Research Activities – Qualified Research Expenses
Work Opportunity Tax Credit
The WOTC rewards employers who hire from groups facing significant barriers to employment, including veterans, people with felony convictions, recipients of public assistance, long-term unemployment recipients, and residents of empowerment zones.8Internal Revenue Service. Work Opportunity Tax Credit
The credit generally equals 40% of up to $6,000 in first-year wages for an employee who works at least 400 hours, a maximum of $2,400 per hire. Employees who work between 120 and 400 hours qualify at a reduced 25% rate. For certain qualified veterans, up to $24,000 in wages can count, raising the potential credit significantly.
Timing is strict. You and the applicant must complete Form 8850 on or before the day you make the job offer, and you have 28 calendar days from the hire’s start date to submit it to your state workforce agency for certification. Miss that window and the credit is gone for that employee, no matter their background.
Section 179 Expensing
Section 179 lets businesses deduct the full cost of qualifying equipment and software in the year it’s placed in service, instead of depreciating it over several years.9Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets For tax year 2026, the maximum deduction is $2,560,000. It phases out dollar for dollar once qualifying property placed in service exceeds $4,090,000, and disappears entirely at $6,650,000.
Qualifying property includes machinery, computers, office furniture, and certain vehicles used in your business. The deduction can’t exceed your taxable income from the active business, so it can’t create a loss on its own. The election is reported on Form 4562 and rolls up with other business credits on Form 3800.10Internal Revenue Service. Instructions for Form 3800 and Schedule A
Energy and Clean Vehicle Credits Have Ended
If you were counting on a federal credit for solar panels, heat pumps, or an electric vehicle, the rules changed in 2025. The Residential Clean Energy Credit under Section 25D no longer applies to any expenditures made after December 31, 2025, even if you signed a contract or paid a deposit earlier.11Internal Revenue Service. FAQs for Modification of Sections 25C, 25D, 25E, 30C, 30D, 45L, 45W, and 179D Under Public Law 119-21 The clean vehicle credits under Sections 30D and 45W ended for vehicles acquired after September 30, 2025.12Internal Revenue Service. Clean Vehicle Tax Credits
Eligible installations and purchases completed before those cutoff dates can still be claimed on your 2025 return. For 2026 and later, these credits are no longer in the federal code.
What to Keep on File
Every claim needs proof the IRS can verify. The exact records vary by credit:
- For education credits, Form 1098-T from the school and Form 8863 with your return.
- For the Child Tax Credit, each child’s valid Social Security number issued before the return’s due date, plus records showing the child lived with you more than half the year.
- For the WOTC, the certified Form 8850, payroll records showing wages and hours, and the state workforce agency’s certification letter.
- For the R&D credit, payroll records tied to specific projects, employee time logs, supply receipts, and contract research agreements. The IRS looks at what employees actually did, not just job titles.
- For Section 179, purchase invoices, receipts, and records of when property was placed in service along with its business use percentage.
Businesses claiming multiple credits consolidate them on Form 3800, the General Business Credit, with each individual credit’s source form attached. Accurate taxpayer identification numbers for dependents and employer identification numbers for businesses have to appear on every return claiming incentives.13Internal Revenue Service. Taxpayer Identification Numbers (TIN)
Filing and Tracking Your Refund
You can file electronically through an IRS-authorized software provider or mail a paper return. E-filing is faster: the IRS confirms acceptance or rejection within 24 hours, while paper returns take significantly longer.14Taxpayer Advocate Service. Options for Filing a Tax Return An e-filed return with direct deposit can produce a refund in as little as ten days and typically within 21. Paper returns can take months.
The IRS “Where’s My Refund” tool shows status 24 hours after e-filing or four weeks after mailing. You will need your Social Security number, filing status, and exact refund amount to check.15Internal Revenue Service. Refunds
If the IRS questions a credit, you’ll receive a letter asking for specific documentation with a response deadline. Ignoring it means the credit is denied and additional tax is assessed.16Internal Revenue Service. Letter or Audit for EITC
Unused Business Credits Can Be Carried Over
When a business earns more general business credits than it can use in one year, the excess isn’t lost. Under IRC Section 39, unused credits can be carried back one year and forward up to 20.17Office of the Law Revision Counsel. 26 US Code 39 – Carryback and Carryforward of Unused Credits For newer or smaller businesses whose current-year tax is too low to absorb the full value, this means R&D spending, targeted hiring, or equipment purchases still pay off eventually. Track the unused amounts and apply them within the carryforward window.
Penalties for Getting It Wrong
Claiming a credit you don’t qualify for costs more than just paying it back. The IRS imposes an accuracy-related penalty of 20% of the underpayment caused by negligence or disregard of tax rules.18Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Negligence includes failing to check whether a credit that “seems too good to be true” actually is.19Internal Revenue Service. Accuracy-Related Penalty
The EITC carries additional risk. If the IRS determines you claimed it due to reckless or intentional disregard of the rules, you’re banned from claiming it for two years after the final determination. If fraud is involved, the ban runs ten years. During the ban, you lose the credit even if you would otherwise qualify.20Internal Revenue Service. What To Do if We Deny Your Claim for a Credit
The IRS generally has three years from your filing date to audit and challenge credits. That window stretches to six years if you underreport income by 25% or more, and there’s no limit for fraudulent returns.21Internal Revenue Service. Time IRS Can Assess Tax Keep your documentation organized and accessible for at least three years after filing.