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.
| Tax Credit | Refundable? |
|---|---|
| Additional Child Tax Credit | Yes |
| Adoption | No |
| 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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Sanjeev says
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.
Warner says
Class A material and grade A explanation in simplicity and scope. Well done.
heho says
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)
heho2495 says
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!)
Tim says
Great article.
Kevin says
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
Projection Scenario:
Last year…
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.
This year…
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.
Tracy says
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
j says
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.
jay says
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.
Randolfo says
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.
Tina says
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.
beth says
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?
Nate says
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.
Scott says
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.
Brian says
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.
Shane says
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.
Josh says
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.
Thanks!
Mike says
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.
Carissa says
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.
Anna says
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.
Bo says
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?
Thanks!
Christian says
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
Donna says
I bought a house this year and I was wondering if the tax credit is a credit or do you get the money?
Tom says
I did not earn any money in 2009. Do I still file a tax return?
Laura says
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!
Kitty says
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.
http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US37F&re=1&ee=1
Jim
vanessa says
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.