Don’t confuse a tax credit with 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 credits. I cover tax deductions in Tax Deductions: Above-the-Line, Standard, Itemized, and Miscellaneous.
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 Refund (R) = Tax Withholding (W) – Total Tax (T)
When they hear that a tax credit is non-refundable, they think they are not going to get the tax credit if they receive a refund versus owe taxes when they file their tax return by April 15, 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 other taxpayers. 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 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.
|Additional Child Tax Credit||Yes|
|American Opportunity Credit||40% refundable|
|Child and Dependent Care||No|
|Child Tax Credit||No|
|Earned Income Credit||Yes|
|Elderly and Disabled Credit||No|
|Excess Social Security Tax Withheld||Yes|
|Foreign Tax Credit||No|
|Lifetime Learning Credit||No|
|Plug-In Electric Drive Vehicle 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?
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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?
Harry Sit says
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!)
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).
Harry Sit says
Kevin – Great question. I haven’t thought about that. It’s non-refundable first, then refundable.
Daniel R. Meadow says
A. I owed $5,429 in taxes.
B. I received $2,791 Earned Income Credit.
C. I received $3,000 Additional Child Tax Credit.
D. This made my total refund go $362 above my withholdings.
A. I expect to owe about $8,000 in taxes.
B. Not sure how EIC will change.
C. I still have 3 children…so Child Tax Credit or Additional Child Tax Credit should be in play.
I’m considering purchasing a new car that would qualify me for the Plug-In Electric Drive Vehicle Credit. My first choice carries with it a full credit of $7,500. The second option is only a $2,500 full credit.
Am I correct to understand that I can fully utilize the $7,500 credit if I purchase the first option (even though it is non-refundable credit) and that the EIC (if I still qualify) and the Additional Child Tax Credit (assuming I can use it over the Child Tax Credit) would further improve my refund because they are refundable? Or would I be safer to only bank on full utilization of the credit if I take my (cheaper) second choice car instead?
Harry Sit says
If you are sure however much child tax credit gets squeezed out you can get it back with the refundable additional child tax credit, your understanding is correct. Refundable credits will give you more money after your tax is already offset to zero by non-refundable credits.
Living Off Dividends & Passive Income says
I believe the lifetime learning credit is 40% refundable for this year and has been increased to $2,500.
Harry Sit says
The new stimulus law expanded the HOPE credit, not the lifetime learning credit. All the credits I listed are as of 2008 tax year.
First Time Filer says
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?
Harry Sit says
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.
Dan Murray says
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?
Harry Sit says
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.
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?
Harry Sit says
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(?).
Harry Sit says
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!
Harry Sit says
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.
Harry Sit says
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?
Harry Sit says
Brian – No, it cannot be carried over to the future years. The overage is effectively lost.
[Edit on 1/23/2010] Although non-refundable credits in general can’t be carried forward, the Residential Energy Credit specifically can be carried forward. See comment #46 from Jim.
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?
Harry Sit says
Shane – That’s correct.
I have been reading about Plug-In Electric vehicle credit. Is this a refundable credit or non-refundable? You may have already answered this but would it be better to not pay any taxes all year just so I can take advantage of the non-refundable credits. It seems to me that I would miss out on them if I am already getting a refund.
I usually do not have to pay any tax by the time the tax credits such as child tax credit, EIC etc. are figured in. I usually get a nice refund from the government and this year I still have money being taken out and did not take advantage of the extra money the gov. is giving people in their pay checks. I also had a home built using the energy star package including heating system. Am I understanding correctly that I will not be able to file for the tax credits for these because I do not have total tax after the credits stated above are applied? I guess in that case, it’s futile to even fill out the forms. I just wanted to ask to be sure.
Thank you for your time.
I don’t understand the adoption tax credit. I know it’s roughly $11000 this year. We have always got a refund back from our taxes. Would the credit just make our refund bigger? Or would we not benefit at all from it? I’m trying to get a grasp on this–we’d like to adopt a child from Russia with special needs but we don’t know how the tax thing works. It’d be nice if we got a refund to help pay for the adoption! Can you explain it to me? I think our liability is actually 0 since we don’t have a very big income to begin with (we are military!)
Can you explain the adoption credit to me?
Harry Sit says
Carissa – Adoption is a nonrefundable credit. If you qualify, the maximum benefit would be reducing your tax liability to zero, which means you get back all your withholding. If your tax liability is already zero without the tax credit, then you don’t get any extra benefit from the credit. If your tax liability is $1,000 without the tax credit, then your refund will be $1,000 higher than what it would be without the tax credit.
its 2009 and my husband and i will file as married filing jointly
if $6,000 were withheld from our combined annual pay for taxes, but our tax liability is only $2000, then we will recieve a $4,000 tax refund, correct?
but let’s add the American Opportunity tax credit into the scenario. let’s say we were eligible for the maximum amount of the $2,500 tax credit, a tax credit that is 40% refundable for tax years 2009 and 2010 .
am i correct in saying that we would recieve the full $6,000 plus $1,000 (2,500 X .40) for a total of $7,000?
Harry Sit says
Anna – Without American Opportunity tax credit, correct, you receive $4,000. With $2,500 tax credit, 40% being refundable, you receive $6,500. The 60% non-refundable credit, which is $1,500, reduces your tax to $500. The additional $1,000 refundable credit reduces it to negative $500. $6000 minus negative $500 is $6,500, not $7,000.
Harry Wyant says
My daughter just bougth a house and they are eligble for a refundable tax credit of $8000. They have paid taxes of about $7500. They now have to buy a furncae that is eligble for the engery creit which is nonrefundable. How will that work? Will the enrgy credit be applies first. H will they get $9500 tax credit?
Harry Sit says
Harry – See comment #8 above. Non-refundable credits are applied before refundable credits.
We don’t make enough money to pay any income taxes. But we do pay the payroll taxes. We are planning to purchase a $4,500 wood stove. Our county has a program to encourage replacement of old wood stoves, and we qualify for a $3,000 rebate. Will we recieve the $1,500 tax credit for the remainder of our purchase? In other words, is the wood stove tax credit refundable?
Hi.. i have a questions that i dont seem to get answer anywhere else in the internet.
i am 22 years old and going to college, im thinking of applying for the american opportunity tax credit.. 2,500 total only 1,000 can be refunded to student…
i do meet all the requirements.. but on the 2009 8863 form.. the american opportunity tax calculation is divided into two areas… refundable and nonrefundable.. and after doing the calculations i got to a line that said “if you were under age 24 at end of year AND meet all the conditions you cannot take the refundable cradit and tells me to move on to the non-refundable part… i was wondering since i never pay taxes.. i mean i do through work and like i just bought a big LCD tv.. what i mean is every year i file taxes i always get money back… my question is i fill out the non-refundable part as it says there.. will i get any money added to my refund at the end of the year… cuz ive been filin since i was 19 and always get the same average money back around 500 cuz i dont have dependants or file any credits until this year that i want to get that credit.
plz help sorry i made it so long
I bought a house this year and I was wondering if the tax credit is a credit or do you get the money?
I did not earn any money in 2009. Do I still file a tax return?
Re: Shane on November 19, 2009
I am confused about the adoption credit (even after reading your answer above). Is it similar to Shane’s question?
A. Total tax: 21,690
B. Total taxes withheld: 21,980
C. Nonrefundable adoption credit: (~$25,000 expenditure-$7500 employee refund is above max amount of $12,150) $12,150
Do we use the same equation? B – (A – C) = Return of $12,440?
Am I totally off? I spoke to an IRS contact guy for 30 minutes and am still confused!
We are retired and entitled to a $1500 credit for our furnace purchase. However, we owe no taxes. Is there a tax form we can fill out so we can use the credit next year?
Peter Larsen says
I don’t think that my situation has been addressed. I am newly retired and do not work for anyone, hence I will not receive a W-2 for 2009. I also do not yet collect Social Security, but plan to start collecting next January, if not sooner. My income comes from the sale of some investments and from rental income on property I own and manage. I consider the property a business. While it may appear that I have lots of money that is not the case. I have to carefully watch my expenses. Since I receive neither a W-2 nor Social Security it appears that I am one of the few folks that falls through the cracks on this particular government stimulus. Would you concur or, if not, could you please let me know what I’ve overlooked. Thank you.
Jim (GraniteViewpoint) says
Re: carry-forward of Residential Energy Credit (form 5695)
According to the last page of the form 5695 instructions (for line 28), it looks like excess credit CAN be carried forward, at least until 2010,.
Also, the source below indicates it can be carried forward for multiple years through at least 2016.
I can’t understand how will the tax credit help me if I owe nothing in back taxes. I’ve filed my taxes, and was disappointed to learn that even though I qualified for the tax credit for an energy effecient exterior door that I had installed, also a new heat pump furnace, that I would not get a refund for these items.
In a nutshell, if you don’t owe taxes, the credit doesn’t help you at all. I was mislead into thinking that I was going to get this money back as a refund!
This was never made clear, and I’m really upset about my big let down. I wanted that money.
Robert Bruaer says
Thanks for this article, it’s great to get clarification on the order of nonrefundable and refundable credits. This is in regards to entry #33. My wife and I are going through the adoption process,and I just wanted to add that while the credit is nonrefundable, the balance that has not been refunded due to not having enough tax liability can be carried over for several years.
Larry Rubens says
My mother has been receiving a foreign tax credit for many years, but has not been able to use it for the last several because she has no federal liability. I am carrying the accumulated credits. If she never incurs a tax liability, will this carryforward be lost? Is there a way to recover it somewhere?
Harry Sit says
Larry – Please refer to IRS Publication 514 on rules for carrying forward the foreign tax credit. If she still hasn’t used the credit by the time the carry forward period expires, the credit is lost.
Jason Hatlestad says
I just bought my first house (March 10, 2010) and qualify for the $8,000 first time home buyers tax credit. I plan on claiming this tax credit for the tax year of 2010. I currently have about $8000 in tax liabilities (money I owe to federal government from job’s paycheck). I understand that the first time home buyer is a tax credit and I get the $8000 regardless of my tax liability. Here is my issue:
I need to purchase a new water heater…if I decide to go with one that meets the requirements for the 30% tax refund of energy efficiency, will I be able to claim it? From what I read, that tax refund states if your tax liability is $0, then you don’t get the money. So what I’m wondering, is will the first time homebuyer $8000 credit reduce my liability to $0 meaning I won’t be allowed to collect on the 30% tax refund for an energy appliance that meets the ratings??
Jason Hatlestad says
I might have figured out my answer by reading comments in Refundable Tax Credit and Non-Refundable Tax Credit. To clarify my question….
1. I have a $8000 Refundable Tax Credit for First Time Homebuyer I’m claiming in 2010.
2. I will owe about $8000 in Tax Liability for 2010.
3. I want to purchase a new water heater that meets the Energy Efficiency Tax Credit which is Non-Refundable. Let’s just say it is worth $750.
If Refundable is subtracted first, my Tax Liability = $0 which means I don’t get the $750. If Non-Refundable is subtracted first, my Tax refund will equal $8,750. Can you verify this for me??
Harry Sit says
Jason – See comments #8 and #38. Non-refundable credits are applied before refundable credits.
Thanks for your comments about refundable vs non refundable credits. We have to replace a broken furnace and all the contractors are telling me that we would get the full 30% tax credit refunded to us regardless of our tax liability; even if we owe $0 in taxes. One even told me he had a paper from the IRS stating that fact, although he didn’t have it with him .
After 3 days on figuring this out myself, I figured out that if my tax liability is only $400 and the heating credit is equal to 30% of $4000 ($1200), then I would only get $400 of the heating credit applied against my tax liability and no refund! Someone needs to clarify this to these heating contractor who are misleading people into believing they’d get the whole credit refunded!
Scenario: I qualify for the child tax credit for $2000 and I have a residential energy property credit of $1200 and my tax liability is $600.
Questions: Would both the child tax credit and energy credit be applied against my tax liability? Would the child tax credit be shifted to the refundable additional child tax credit? Would the child tax credit be divided between the child tax credit and additional child tax credit?
I know in your chart that it says the child tax credit is nonrefundable, but how does this scenario affect the additional child tax credit (refundable)?
If i’ve figured this out correctly, the child tax credit and the additional child tax credit combine equal the credit amount one qualifies for, so if you can’t use the child tax credit against your tax liability it shifts to the additional child tax credit and you get it as a refund right?
Harry Sit says
Julie – The amount of child tax credit that can shift to refundable is capped by your income. You will have to follow the IRS worksheets in Publication 972 and see how much will shift. If you are in the right sweet spot, it’s possible 100% of the child tax credit becomes refundable for you.
Tom Tomich says
What happens if you have excess non-refundable credits? Can they be carried forward to the next tax year or are they just lost? Specifically I am talking about a credit for putting solar panels on my home.
Harry Sit says
Tom – Some nonrefundable credit can’t be carried forward and some can. Specifically the credit for solar panels can be carried forward to at least 2016.
Scenario: I have $26,000.00 (30% of cost) federal credit for solar panel installation and a $1,500.00 federal credit for high efficiency heating/cooling unit. My tax liabality we”ll say is $10,000. I overpay may taxes to the tune of $18,000.00.
I’m not sure if these credits are added together then applied or is there an specific order in which they must be used. I read the solar credit can be carried over to the following tax year(s),however, the HVAC cannot. Would I get back the overpayment of $8,000 + $10,000 ($1,500.00 HVAC + $8,500.00 solar) leaving me with a balance credit of $17,500 (solar) which I would carry forward to the next tax year.
I assumed the solar credits were non-refundable for this scenario, however , if I’m incorrect, please advise.
Harry Sit says
@FREE – You did it correctly.
Hello – first off, great article! I’m a former CPA and still had a hard time finding articles that clearly explained how non-refundable credits work. Please confirm my understanding of my current situation:
I qualify for the California New Home State Credit of $10K (to be applied in 3 equal, annual, installments), so $3,333 each year. This credit is non-refundable.
Though I claim a “9” in withholdings, I still typically receive a state tax refund due to mortgage interest and property tax deductions. I expect to receive a refund again for the 2010 tax year.
Because I have had more than $3,333 state taxes withheld from my paycheck, am I still eligible to receive the $3,333 first installment of the tax credit in addition to whatever I’m already owed as a result of overpayment?
This article very clearly explains the refundable tax credit. Just to clarify, every time the taxes owed is below zero due to a refundable tax credit and a person receives money from the government beyond their income withheld, this is money that essentially comes out of the income of other taxpayers who paid taxes since “the government” has no money except tax money. Correct? Thoughts?
Regarding Ben’s previous comment, W2 wage earners with zero income tax liability are still paying payroll taxes as is their employer (about 15% marginal rate combined). I believe a majority of filers now pay more in payroll tax than income tax, and percentage of total govt revenue from each source is pretty similar (40-ish % of total federal revenues from each source). So one shouldn’t equate taxes with income taxes and forget that the payroll tax exists.
When one has refundable and non-refundable credits the order in which they are applied often matters. Among the IRS pubs, I was never able to figure the order out… only way to determine this was to do my Turbotax return early and see what the resulting return came out to.
Harry Sit says
@Kevin – You are correct people still pay payroll tax if they work. However they also expect to receive Social Security and Medicare when they retire. Payroll taxes can be seen as prepaying for future benefits even though technically they go to current recipients.
That’s one way to think about it, but it strikes me as social security lockbox thinking. First, it’s not clear what benefits will actually accrue to a given individual decades down the line (rules will change, person might not survive to retirement).
Also by the same logic, should I discount in a similar way significant portions of my income taxes because those funds flow into agricultural subsidies to ADM or defense budget contracts with Boeing (both of which have immediate benefits to my index fund holdings and my local economy this year and not decades down the line)? For these reasons, I consider payroll taxes to be just taxes.
Great article..it explained a few things I have been wondering…but I am still blurry on my situation.
My husband owes from a previous year, however we qualify for a few tax credits this year. Will those credits pay what he owes from then or will they pay off what we owe from or total refund?
^^If that doesnt make sense I’m sorry! I have worked myself into a frenzie!
Just one small quibble. In your otherwise excellent article, you say that if 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. ”
That extra $500 isn’t something you are getting “back” from the government, since you never gave it to them in the first place. Many, if not most EITC filers are unaware that the check they receive each year is in fact a cash payment from taxpayers to them. It’s income redistribution, disguised as a tax refund.
Harry Sit says
@Dave – Thank you for the correction. I struck out the last “back” in the sentence you quoted.
Dave comment 67.
EITC filers give money to the government via the payroll tax (15% effective rate; half from your employer), and most are only “getting back” that amount or less. There is a subset of EITC filers (generally if you have 3 or more kids) that get more than their payroll taxes, so that could certainly be considered as cash welfare. From a public policy standpoint though, EITC (which expanded in Reagan 1986 tax reforms) is far superior to welfare/food stamps/etc. in that it gives clear incentives for people to earn income.
#46 regarding jim’s comment:
i think that does not include the part 1 (nonbusiness energy property credit) of form 5695, for windows etc….as far as carryover goes….just part 2 for solar etc. credits are carryover to next years
I’m still confused. I qualified for a $6,552 Sustainable Building Tax Credit in New Mexico. It’s a non-refundable credit, so does this mean I won’t actually see this money in the form of a refund? Altogether, I’ll get about $4800 back from my federal and state returns. When I entered the tax credit on my e-file form it didn’t budge either return. Should I raise the number of exemptions I claim since I’ve got this credit under my belt?
(addition to previous comment) Or is this credit only applicable to state taxes since it’s a state credit?
Harry Sit says
@SDPinky17 – If it’s a state credit, it’s only applicable to state taxes.
About tax credits.I have inherited 35,000.00 in tax credits. Are these refundable or non?
Harry Sit says
@marlin – You are correct about carrying forward tax credit for residential energy efficiency improvements. Only credits for solar panels, geothermal heat pumps, solar water heater, small wind energy systems, and fuel cells can be carried forward. Tax credits for other products can’t be carried forward. See
Question on the Adoption Tax carryover…child’s adoption finalized in 2009. For 2009, our adoption credit was $5,311. Our return indicated that we would be able to carryover $6,839 on 2010 taxes. So, now I am working on my 2010 taxes and I’m using HRBlock.com to do them. When I get to the part about the adoption carryover, I enter my $6,839. It is not changing my refund amount at all…I’m not understanding this, because I was told that we would get the total $12,150 (total adoption credit for 2009) back over a period of 5 years. Can you help me to understand if this is correct? Thanks!!
Harry Sit says
@Carol – Sorry I have no idea what HRBlock.com is doing. Print out the tax forms and see where it entered the carryover. Remove that carryover and print out the forms again. Compare and see what changed.
Question on the Residential Energy Improvement Credit – I was single in 2009 and lived by myself and took advantage of the $1500 credit on my home. I then got married in Mar 2010 and I moved into my husband’s house. We made improvements to this house in 2010 that would qualify for the credit. My husband did not take advantage of the credit yet. Should we file MFS so he can take advantage of the credit for $1500? Or do you think we can file MFJ and take the credit again? OR is the credit not available to him anymore because I took it in 2009 when I was single? Thanks!!!
matthew botsford says
I owe 2,853.00. I have the maximum of 1500. from a 15,000.00 window job(30%) from the residential tax credit but it says I get $0.0 for it. Why?
I noticed that for year 2010 those that took advantage of the First-Time Homebuyers credit are required to pay it back.
Which of the credits listed above have to be paid back at a later time?
Harry Sit says
@Ana – The first-time home buyer tax credit is an odd ball. There were three versions with different qualifying purchase periods. Only the first offer requires a payback. It’s not a true tax credit, but merely an interest-free loan. The second and third versions were true tax credits. All other tax credits are also true tax credits and don’t require a payback.
Was also wondering about refundable and non-refundable order. Thank you for the article. 🙂
My CPA tells me that my $7500 non-refundable tax credit can only be applied on taxes that I haven’t paid. He advises me to not pay taxes for the rest of the year so that the credit can be applied on taxes not paid yet. Is this true? It doesn’t seem to make sense to me. I have paid more than $7500 in taxes from my paycheck withholdings so why wouldn’t I get that back. Please help! This is an emergency!
Gary Raddatz says
Hi, I need help with this one! I bought a new geothermal furnace last November. Now I’m trying to figure out my taxes. It looks like I would enter the 30% number on line 52 of my 1040, which would lower my tax owed from line 46 and be my number on line 55. So, I don’t see how it matters in the end if I owe taxes or I’m getting a refund? It looks like it will add to make an additional refund. But I know it is considered a non-refundable credit. As long as I paid in more than the credit is worth, it seems I will get it.
From the article in bold: “Non-refundable does NOT mean it’s not going to be included in the tax refund.”
Mary J. says
Our situation may have already been discussed in the previous blogs, but here it is: Husband & I are getting $15000 (30% of cost) fed tax credit from solar energy installation. We both claim Single/zero allowance on our W4 which helps us a lot when April comes. Together we make almost $300k. Can we reduce our tax withholding this year by $1500/month ($15000 divided by 10 months)? I used 10 months coz it’s now almost March. By doing this we hope to use up the credit. Any advise will be greatly appreciated.
Yes you can do that if you want the money sooner, or you can just wait for a larger refund next year.
Mary J. says
Harry, thanks for the quick response. However I don’t think we’ll see a refund if we wait. We don’t expect any tax liability come next April to take advantage of the 30% tax credit. It will stay as credit and rolled over thru 2016.
Your total tax isn’t just the amount you owe in addition to your withholding. It’s the amount of tax you must pay, regardless how you pay, whether by withholding or by writing a check. Come next April when your withholding exceeded your total tax for the year after the credit, you will get the extra withholding back. A non-refundable credit only means it can’t take your total tax below zero. With a $300k income I’m sure you pay more than $15k in total tax. When your total tax is high enough it doesn’t matter whether the credit is refundable or nonrefundable. That’s the whole point of this article.
Mary J. says
Harry, thank u so much for your explanation! Sorry but I was just going by what my solar sales person told me yesterday. After reading & understanding this article (which I should have done in the first place, my bad) I can now tell this person that we can actually claim the full value of the credit coz our total tax liability exceeds the credit’s value, right? Thus, withhold less tax now or see it as refund next year. Thanks again!
That’s right, as I wrote in the reply to your first comment last night.
This was the most helpful! Basically…if your total taxes owed for the year EXCEED the tax rebate amount…then you could get a refund after all of your other payroll deductions and credits are applied. Because the non-refundable rebate is applied first to reduce your tax liability. BUT…if your total taxes owed for the year are LESS than the rebate amount…then it just reduces your tax liability to zero. For example: You owe a total of $36,000 in taxes. You apply a $16,000 rebate to the total taxes owed which reduces your amount owed to now $20,000. Subtract your payroll taxes paid, other credits, mortgage interest, etc. on top of this and you will likely see a refund. I think I got it!!!
Brian McMahon says
Are tax credits, that are available to qualified applicants through the health insurance marketplace, refundable or non-refundable? What is the minimum income a family of two must have to qualify for tax credits? I ask this because last year I was denied tax credits because my wife and I earned too much to qualify for State Medicade but not enough money to qualify for tax credits.
Harry Sit says
The premium tax credit under Obamacare is refundable. You have a second chance to get it when you file your taxes for 2014. Raise your income above the threshold to make you qualify. Converting some traditional IRA money to Roth is the easiest way.
Ronald Testa says
It is my understanding that if I own money on 2014 income tax return only because of the premium tax credit repayment that the IRS–if I do not pay it back–cannot levy, garnish or, charge me interest or penalties on the amount that is due. They can only reduce any current and future refunds that I may receive. The situation I have here is a client who did not have enough income to file a tax return for a number of years and is only filing this year due to the fact they received a Form 1095-A. They have no funds to repay this excess credit back and the repayment is due to a misunderstanding on what income is included in determining the amount of their monthly premium credit. In error they used the AGI on their 2013 Federal return–one was prepare, but not filed, just to determine what their income would be–which of course did not include any untaxed amount of their Social Security.
If the above statement is true please advise and please provide me with official IRS/healthcare code citations that I can refer to in case of an IRS audit.
My wife and I bought a new house in 2014 which came with a new solar system. we file our taxes jointly and our total income was 247,000. the form 5695 which showed we should receive a credit of $4,535. I got a notice from the IRS that states it did not allow all of the credit ( they only accepted $1,000 and denied $3,535) because on line 53 of my 1040 is limited to the total amount of my tax liability.
I am very dull on tax stuff but this did not seem right, am I wrong and should only get $1,000
Harry Sit says
Line 47 is your total tax liability. Lines 48-54 are your non-refundable credits. You add them up on line 55. Then line 56 says “Subtract line 55 from line 47. If line 55 is more than line 47, enter -0-” If your non-refundable credits exceeded your total tax liability then you are not going to get the full credit.
Sorry it took so long but I got out my copy of my 2014 taxes.
Line 47……..42,109 (tax liability)
Line 55……….4,535 (total of non refundable tax credits i.e. Solar)
Line 56……..37,574 (new tax liability)
So my 4,535 tax credit is far from exceeding my tax liability.
Am I missing something here???
Harry Sit says
Call them or write back and point that out to them?
Hi, great article and great explanations. I fully understand the refundable and non-refundable credits with regard to total tax and tax withholding. I also understand that non-refundable credits are applied before refundable. However, this is what I am still unsure about: we installed a solar panel system this year, which will be a $12,000 non-refundable tax credit on next years taxes, we have two dependent children, and, my husband’s income went down drastically, so we will probably qualify for some Earned Income Tax Credit. The child tax credit is non-refundable, so we would be better with the additional child tax credit. Is the EITC refundable if we have completely reduced our tax liability to zero, and would we be able to use both the additional child tax credit and the EITC. If so, then my understanding is that the scenario go like this:
A. Total Tax: 5,000
B. Tax Withholdings: 3,000
C. Solar Panel Credit: 12,000 (use 5,000, 7,000 rollover)
D. Additional Child Tax Credit: 2,000
E. Earned Income Tax Credit: 2,000
B-(A-C)+D+E= 7,000 refund
Is this correct?
Harry Sit says
I’m not an expert on EITC or additional child tax credit. Your math looks good to me.
Excellent article, thanks. This answered a lot of questions I had and cleared up some misunderstandings.
Thank you for a clear, clean explanation of the how the tax credit applies to the cost of renewable energy installations. I am an installer of renewable energies and homeowners always have questions about the process. I will amend my estimates and cost-breakdowns to include the phrase “non-refundable” when detailing the available federal tax incentive.
So I’m somewhat confused on the solar tax credit. My wife and I have a combined income of around $90k. We both claim single and zero dependents. We normally receive a tax refund of around $4000. Our solar tax credit is just over $3000. I understand that it’s a non-refundable credit. What I’m thinking is that we should change our withholdings to benefit from the credit next year, since whatever we don’t use this year will roll over. We won’t use any of the credit this year, due to receiving a refund. But I can try to owe $3000 next year to use that credit. Am I thinking correctly? Or is there something I’m missing?
I just read your response on another question above. The tax credit not used this year will roll over and be used next year and then I will receive back $3000 more of my withholdings than I would have…..correct?
I don’t understand why my refund is not as high as what I would have considered a much higher calculated refund. With my limited knowledge, would it be because I qualify into the low end of a tax bracket that I have in previous years qualified into the higher end of a lesser bracket. If I could please get a brief answer on how the tax bracket decides on the aggregate refund, would this be a reason why I am getting a lesser refund than previous years? With that being said, would making around 33% more cause me to receive less?
I feel duped by the IRS….
I searched and searched and searched for information related to the Electric Vehicle Tax Credit. After studying diligently, it became self-evident (given the IRS information available and feedback from such forums as this) that I could utilize pretty much all of a $7,500 non-refundable credit for purchasing a Chevy Volt. So I made the purchase on November 30, 2015.
Now that it’s filing time, my trusty Tax-Act program tells me I can only use $754 of the credit!!
Here’s why…. I am self-employed, and a large chunk of what I understood to be my $8,000+ in tax liability is actually Social Security Tax liability instead of Federal Tax liability.
So even though the nonrefundable EV Tax Credit is resolved first in our return (which should have ensured that I received ALL of my $3,000 refundable Additional Child Tax Credit, it turns out that the EV Tax Credit is actually resolved even further up the chain so that it ONLY applies to our Federal Tax Liability and not to any of the “Other Taxes” Category into which our Self-Employment Tax falls.
So my Federal Tax Liability of $1,954 (line47) was reduced $1,200 by my Credit for Child & Dependent Care (line49). Then it was further reduced $754 by my EV Credit (line54 according to TaxAct), which left me at $0 with $6,746 in wasted EV Credit!
THEN, my Self-Employment Tax of $5,425 was added (line57) followed by my Household Employment Tax of $426 (line60a) which left me with a total of $5,851 (line63).
Next, my wife’s tax withholdings reduced this total by $1,651 (line64). And then our Additional Child Tax Credit further reduced the total by $3,000 (line67). So we are left owing $1,200 (line78).
This is a sad sad reality for us to discover at this point.
How could we have known that the IRS would put this credit at line 54 when our only experience of similar tax credits had always come at line 67 and following?
I would have never known what the line sequence would be on the tax form prior to filing. And it seems to me that most tax laymen wouldn’t know this information either. That’s why I feel duped. IT IS NOT MERELY A QUESTION OF REFUNDABLE VS. NONREFUNDABLE AND TOTAL TAX LIABILITY.
If we had only waited til January 1 to purchase the new car….
Is there any way avoid claiming the EV Credit altogether for 2015 and to still claim it in full for 2016?
I make about a 100k a year but have lots of deductions so I don’t end up paying anything at the end of the year. I live in Cali so for an electric car I would get a credit of 7500 fed and another 1500 state. Non refundable 9000 in credits. If I already get my taxes down to zero from deducutions will I get any of that 9000 in credits?
Harry Sit says
The federal one is the “Plug-In Electric Drive Vehicle Credit” in the table. The answer is “No.” If you want to get it you need to try to increase your tax liability by creating more income, such as by converting some money in a pre-tax Traditional IRA to Roth IRA. The California state rebate isn’t tied to your tax liability. It only sets the eligibility on your income.
Lorraine Scharff says
solar tax credit. Can the owner take the credit over the course of multiple years even if he doesn’t live in the home anymore where it is installed?
Harry Sit says
I suppose so. Read Form 5695 instructions.
Jim F says
Hi. I have total tax liability of 5500. I got solar panels and 30% is about 9200. I have 3 kids so I know I can claim 1,000 for each child for the child tax credit. Would the solar panel credit bring my liability down to 0 then claim the child tax credit to money back or do I lose the child credits?
Neil L says
Fantastic, thank you. After reading up on the issue, I was suspicious that this was how non-refundable tax credits worked, but I could not find a single source before now to clarify.