Refundable Tax Credit and Non-Refundable Tax Credit
If you read and paid attention to the previous post Tax Breaks In Stimulus Bill for Buying a Home Or a New Car, you would see that the proposed tax break for buying a home is a tax credit while the tax break for buying a new car is a tax deduction. If you are not sure about the difference, it's a good time to clear up some tax terms. For the sake of length, this post will only cover tax credit. Let's look at tax deduction at another time.
A tax credit directly reduces your tax, dollar for dollar. If you are supposed to pay $5,000 in tax, a $500 tax credit reduces your tax to $4,500. On the other hand, a tax deduction reduces your taxable income, which indirectly reduces your tax. If you are supposed to pay $5,000 in tax, a $500 tax deduction reduces your taxable income by $500. If you are in the 15% marginal tax bracket, it reduces your tax by only $500 * 15% = $75. Therefore a $100 tax credit is worth a lot more than a $100 tax deduction.
Within tax credits, some are refundable tax credits and some are non-refundable tax credits. Here the word refundable often causes confusion because most people refer to the difference between their tax withholding and their total tax as the tax refund.
Tax Withholding (W) – Total Tax (T) = Tax Refund (R)
When they hear that a tax credit is non-refundable, like the proposed $15,000 tax credit in the stimulus bill for buying a home, they think if they receive a refund versus owe taxes when they file their tax return by April 15, they are not going to get the tax credit, because the credit is, uh, non-refundable. Actually that's not the case. Non-refundable does NOT mean it's not going to be included in the tax refund. It has to do with how it works against your total tax (T) in the above equation. That's the total tax you are supposed to pay for the year after all the adjustments, exemptions, deductions, and credits are taken into consideration. Most people already satisfied that through tax withholding on their paychecks or by making estimated tax payments.
A refundable tax credit can reduce your total tax to a negative number, which means the government pays you. For example suppose your total tax before the tax credit is $1,500, a $2,000 refundable tax credit means you not only get back everything you paid through tax withholding, but you also get an extra $500 back from the government. Your total federal income tax for the year is negative. A non-refundable tax credit can reduce your tax to zero but your tax can't go below zero. For example suppose your total tax before the tax credit is $1,500, a $2,000 non-refundable tax credit means you will get back everything you paid through tax withholding and that's it. Your actual benefit from this non-refundable tax credit is $1,500, not $2,000. If you pay enough taxes, it doesn't matter whether a tax credit is refundable or non-refundable. Otherwise, a $100 refundable tax credit is better than a $100 non-refundable tax credit.
The following table lists some of the tax credits (as of 2008 tax year) in alphabetical order. All the links point to the official IRS web site for that topic. Every tax credit has a unique set of qualification rules. Out of 15 tax credits listed here, five are refundable; the other ten are non-refundable.
| Tax Credit | Refundable? |
| Additional Child Tax Credit | Yes |
| Adoption | No |
| Alternative Motor Vehicle Credit | No |
| Child and Dependent Care | No |
| Child Tax Credit | No |
| Earned Income Credit | Yes |
| Elderly and Disabled Credit | No |
| Excess Social Security Tax Withheld | Yes |
| First-time Homebuyer | Yes |
| Foreign Tax Credit | No |
| Health Coverage Tax Credit | Yes |
| HOPE Credit | No |
| Lifetime Learning Credit | No |
| Residential Energy Efficient Property Credit | No |
| Retirement Savings Contributions Credit (aka Saver's Credit) | No |
I doubt anybody can recite all the rules without a reference book. CPAs included. How many credits do you qualify?
Software picked, likely related posts:
- Tax Cuts in Stimulus Bill Updated
- Tax Credit for Buying a Hybrid or Diesel Car
- Tax Breaks In Stimulus Bill for Buying a Home Or a New Car
Comments
30 Comments on Refundable Tax Credit and Non-Refundable Tax Credit
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Sanjeev on February 11, 2009 |
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heho on February 11, 2009 |
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heho2495 on February 11, 2009 |
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Tim on February 12, 2009 |
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Kevin on February 13, 2009 |
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Living Off Dividends & Passive Income on February 17, 2009 |
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First Time Filer on February 19, 2009 |
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Dan Murray on March 12, 2009 |
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Tracy on March 26, 2009 |
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j on April 7, 2009 |
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jay on April 7, 2009 |
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Randolfo on April 10, 2009 |
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Tina on July 20, 2009 |
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beth on July 22, 2009 |
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Nate on August 4, 2009 |
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Scott on September 10, 2009 |
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Brian on September 25, 2009 |
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I am not clear about one part though. Say my annual taxable income for 2008 is $10,000. My tax will amount to $1,000. Lets say I have a non-refundable credit of $1,000 avaialble to me. What happens in the following situations?
A – I have paid $1,100 taxes in 2008 by having taxes withheld from paycheck. Do I get a refund? If yes, how much?
B – I have not paid any tax in 2008. I still owe $1,000 dollars in taxes. What amount will I end up owning in this situation?
C – I have paid $800 taxes in 2008 by having taxes withheld from my paycheck. Do I pay anything? Do I get a refund?
The reason I am asking these questions is that if the bill to provide homebuyers with a non-refundable $15,000 tax credit is approved, then do I need to engage in some kind of tax-planning so that, when the time comes to file 2009, I need to owe about $15,000 in taxes to utilize the credit to maximum?
Sanjeev – Thank you for providing the examples for clarification.
A) You get a tax refund for $1,100.
B) You owe nothing and receive nothing.
C) You get a tax refund for $800.
In all three cases, the non-refundable tax credit reduces T by $1,000 but not below zero, in the equation W – T = R. Your tax planning will be on changing T, making sure you have enough income and pay enough tax, not on changing the amount of withholding W.
Of course if you qualify for the tax credit, you can change your tax withholding to get your tax credit during the year versus waiting until you file your tax return. But that has to do with only the timing of the credit, not the amount of the credit.
Class A material and grade A explanation in simplicity and scope. Well done.
So if govt is giving $15000 credit for buying home and my tax liabilities are $5000 for the year, will govt give me back $15000 or $10000 or $5000 (I assume payroll tax doesn't even come in picture)
I re-read the article, and to answer my own question, I will get back $5000 if I already paid it else it will offset all payable taxes upto max of $15000. Credit not offset by taxes will be wasted (Or should I say- uncle sam will pocket it!)
Great article.
In what order are federal tax credits applied?
Let’s say you have $500 in refundable tax credits and $500 in non-refundable credits and a $500 in total tax liabilities none of which you have paid. If the refundable credits are applied first they zero out the tax and then you would get no refund (extra non-refundable $500 credit wasted). However, if the non-refundable credit is applied first and that zeroes out your tax liability, you’d still get the $500 refundable credit. I’m guessing it’s the former no refund situation, but can you clarify?
This situation might apply to people who are eligible for both kinds of credits (e.g. non-refundable child tax credit and 2009 refundable stimulus credit).
Kevin – Great question. I haven't thought about that. It's non-refundable first, then refundable.
I believe the lifetime learning credit is 40% refundable for this year and has been increased to $2,500.
The new stimulus law expanded the HOPE credit, not the lifetime learning credit. All the credits I listed are as of 2008 tax year.
This is my first year filing income tax on my own. I'm not too sure what I am suppose to do. I used the QuickTax 2008 program to help me, but when I was done, I wasn't sure if i did it properly, and I don't understand all the numbers on the sheet. I am not working so I don't have any income to report, but when I filled out the Federal Tax form, the amount of $9,600 appeared for my Basic Personal Amount, and I don't know where that amount came from or what it is for. Also, at the very bottom it tells me to multiply the amount by 15% which gives me a total federal non-refundable tax credit of $1440. What do these numbers mean? Does it mean i have to pay the government $1440? Or if this amount doesn't affect anything, then what is the purpose of it?
First Time Filer – Sorry I can't help you there because QuickTax and Basic Personal Amount are for Canada. I live in the U.S. This post is about the U.S. I have no idea how it works in Canada.
If I'm retired and do not have to file tax returns at the end of the year, can I still claim the up to 30% energy tax credit and receive a refund check because I will owe no taxes at the end of the year on qualified improvements to my home?
Residential Energy Efficient Property Credit is not refundable. Added to the list with a link to the tax form. See instructions in the tax form.
I have a question. I was disabled in 2005, and have been waiting for my application for social security disability to go thru. It did in June of 2008. I received a couple big checks for the past 3 years, and then a amount monthly. Am I eligible for the 2009 stimulus check of 300.00 even though I did not file a tax return last year, and do I have to file one this year in order to get it? I am so confused.
Tracy
A question please. Tax liability for 2009 will probably be less than $700 with $1400 federal taxes deducted. If I put 95% eff. furnace in and receive the 30$ rebate can I use $700 towards the 2009 tax liablity and roll the balance forward to be used against the 2010 tax liability? Thank you.
A question please. An estimated tax liability of $700 with $1500 federal tax withdrawn. I purchase and install a qualifying furnace for the 30% rebate of $1500. Can part of this be used for the 2009 tax year and the balance be rolled forward to be used against the 2010 tax liability?
jay – If I understand you correctly, you estimate you will pay $700 tax in 2009. A non-refundable credit of $1,500 * 30% = $450 will reduce that to $700 – $450 = $250. Then you will get a refund for $1,500 – $250 = $1,250.
This may or may not be related, but I'll ask. With the new "Making Tax Pay" refundable credit – the gov is "giving" me an extra $30 or so every paycheck. This is like getting the refundable credit in advance. However, at the end of the year, am I getting taxed on this credit – will i pay taxes on this credit the following year? You explained the refundable/non-refundable tax thing in a clear no-nonsense manner – maybe a new article on this whole ARRA thing and how it works in your clear no-nonsense manner would be beneficial(?).
Randolfo – It's "Making Work Pay" not "Making Tax Pay" 
It's exactly as you described: getting the refundable credit in advance. No, you will not be taxed for this new credit. They are "giving" you the extra $30, not by adding it to your income, but by reducing your tax withholding.
I expect a new line on the tax form for this credit next year, like the lines for the existing refundable credits. You have to complete that line to claim the credit. But because they already reduced your withholding, you won't get a larger refund. Remember the equation I wrote in the post:
Tax Withholding (W) – Total Tax (T) = Tax Refund (R)
A smaller W minus a smaller T equals the same R. Some people will not be eligible for this credit, but their employer still reduced their withholding. In that case, they will have a smaller refund or owe more next year. Some people have two jobs. Both employers will give them the reduced withholding. But because they can only claim one credit, they will also have a smaller refund or owe more next year.
my dont understand why my hubby paid $10000 in tax and only got $1100 back. His brother paid no where near that and got $2000. both personal circumstances are exactly the same except the gross earnings and witholding tax amounts.
i think its a bunch of BS…For one thing it should be from 1/1/09 to the end of dec of 2009. What happens to the honest workeer who had to buy a car in January?
Do you know if the Alternative Fuel Motor Vehicle credit is a refundable or non-refundable tax credit? Primarily the 2009 Jetta tdi clean diesel?
I assume it's non-refundable, but hopefully I'm wrong!
Nate – It's non-refundable as you assumed. Thanks for bringing it up. I added it to the list. 2009 VW Jetta TDI falls under Qualified Advanced Lean-Burn Technology Vehicles. $1,300 tax credit.
Call me an idiot but I still dont get it. If at the end of 2009 I am entitled to a 500 rebate check from the govt, and then I add in that I spent 3000 on new windows, will my rebate increase? I am already getting 500 back so I must have withheldW) more than my tax (T). Sorry if I am missing it. Thanks for any help.
Scott – It depends on what your tax is to begin with. If your tax is $2,000 and you withheld $2,500, and if the $3,000 for new windows is a non-refundable credit, your refund will increase, but only increase by $2,000, from $500 to $2,500. However, if your tax is $5,000 and you withheld $5,500. The same $3,000 non-refundable tax credit will increase your tax refund by $3,000, from $500 to $3,500.
Can non-refundable credits (such as the energy tax credit) be carried forward for individual/joint tax filers so that the full value can be used-up in subsequent years if Credit (C) > Tax (T) in the year that the initial credit was requested? To clarify, if C = $1000 but T = $700 (assume W = 0) in 2009, can I take a $300 credit on 2010 taxes?
Brian – No, it cannot be carried over to the future years. The overage is effectively lost.
I have a question. Say for 2009, I paid tuition expenses which are eligible for one of the tuition credits. Since these credits can't give me a negative tax liability, is it safe to say that I can deduct these from my tax liability, and then have the first time homebuyer tax credit on top of that?
Let's break down numbers with an example:
A. Total Taxes Owed: $3000
B. Total Taxes Withheld: $3500
C. Eligible Tuition Tax Credit Amount: $1000
D. First Time Homebuyer Credit: $8000
Does this mean I will get $9500 back?
B – (A – C) + D = Return
Am I correct?
Shane – That's correct.
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