Tax Credits – Refundable and Non-Refundable
Millions of taxpayers overpay on their taxes every year because they do not take advantage of all
the tax credits that they are entitled to. Overlooking some of your tax credits can be a very costly
mistake. Claiming all the credits that you are legally entitled to will allow you to save money,
because credits reduce your tax liability dollar-for-dollar.
At this point, it should be pretty useful to make a distinction between adjustments, deductions,
and credits. Adjustments reduce total income and result in adjusted gross income (AGI).
Deductions (including exemptions) reduce adjusted gross income and result in taxable income.
Credits, on the other hand, reduce your tax liability on a dollar-for-dollar basis.
Credits are of two types: nonrefundable and refundable. Nonrefundable tax credits can reduce tax
owed to zero, but can’t be used to get a refund if they exceed the tax. Refundable credits, on the
other hand, after they reduce your tax to zero, they can provide you with a refund. Most credits,
however, both nonrefundable and refundable, are gradually reduced as your income increases,
and are eventually phased out and reduced to zero after your income surpasses a certain level.
Defining Nonrefundable Credits
A non-refundable tax credit is a credit that can reduce the amount of an individual’s tax liability
to zero, but cannot exceed the total amount of income taxes owed. For example, if you have a
non-refundable tax credit of $5,000 and a tax liability of $3,000, the credit will eliminate the tax
liability, but the IRS will not refund the remaining $2,000 of the non-refundable tax credit.
Nonrefundable credits include the following:
Credit for child and dependent care expenses.
Child tax credit.
Residential energy credit.
Foreign tax credit.
Credit for the elderly and disabled.
Credit for qualified alternative vehicles.
Retirement saver’s tax credit.
Defining Refundable Credits
A refundable tax credit, on the other hand, is not limited by the amount of an individual’s tax
liability, but can go beyond that, and can reduce an individual’s tax liability below zero. In the
above example, if the tax credit were a refundable credit, the IRS would refund you the $2,000.
Refundable credits impact on your total tax liability as follows:
They are reported in the payments section of Form 1040, and are thus treated as
They are subtracted from your total tax liability on line 61, Form 1040.
They can reduce tax liability to zero, and result in a refund if the credits are greater than
the tax liability.
The total amount of your refundable credits is refundable to you, even if there is no tax liability,
or no taxes were withheld from your income.
Refundable credits include the following:
Earned income credit.
Additional child tax credit.
American opportunity credit (see next chapter).
First time homebuyer credit.
If you are serious about doing your own taxes, you will find these two publications to be pretty
helpful: “How To Save Money By Ensuring That Your Tax Returns Have Been Properly
Prepared” and “How To Use Turbo Tax To Confidently Prepare Your Tax Returns.”
Available in Kindle format and in paperback
Visit: www.mgbfinancials.com or visit www.amazon.com