What Is a Non-Refundable Tax Credit?
A non-refundable tax credit is one that can only be used to decrease a taxpayer’s burden to zero. In general, any amount of a non-refundable credit that exceeds a taxpayer’s obligation is immediately lost.
Non-refundable tax credits are preferable to refundable tax credits for taxpayers who have little or no tax burden.
- A non-refundable tax credit is a form of income tax break that lowers your obligation by the same amount.
- A non-refundable tax credit may only be used to decrease tax burden to zero.
- A non-refundable tax credit does not diminish a taxpayer’s taxable income; rather, it is applied straight to the tax payable.
- A non-refundable credit, unlike a refundable credit, does not result in a tax refund if the amount of the credit exceeds the tax payment.
- Non-refundable credits in the United States tax law include, among other things, the overseas tax credit and the saver’s credit.
How Non-Refundable Tax Credits Work
The tax system of the United States gives various tax breaks in the form of tax credits, which decrease the tax burden of qualifying taxpayers. A tax credit is allocated to the amount of tax payable by the taxpayer after all deductions from taxable income have been made. A tax credit decreases an individual’s overall tax payment dollar for dollar.
Refundable vs. Non-Refundable Credits
Tax credits may be refundable or non-refundable. If a refundable tax credit exceeds an individual’s overall tax due, a refund check is normally sent. When a taxpayer applies a $3,400 refundable tax credit to a $3,000 tax bill, the amount is lowered to zero, and the remaining part of the credit, $400, is returned to the taxpayer.
A non-refundable tax credit, on the other hand, does not result in a return to the taxpayer since it simply reduces the tax payable to zero. Following the above example, if the $3,400 tax credit is non-refundable, the person owes nothing to the government but forfeits the $400 that is unused after the credit is applied.
Tax Deductions vs. Tax Credits
If a person owes the government $3,000 and is entitled for a $1,100 tax credit, he will only have to pay $1,900 once the credit is applied. A $1,100 tax deduction decreases a taxpayer’s taxable income by the same amount.
The choice between a tax credit and a tax deduction is determined by the taxpayer’s marginal tax rate. If a person is eligible for a $100 deduction and has a 30% marginal tax rate, the deduction will save the taxpayer $30. If the same individual is eligible for a 50% tax credit on a $100 spend, the savings is $50. If the same individual claims a 20% tax credit on $100, the savings is just $20.
Tax Deductions Vs. Tax Credits
In contrast to tax deductions, which lower taxable income, a tax credit reduces the amount of tax owed dollar for dollar.
Examples of Non-Refundable Tax Credits
Non-refundable tax credits that are often claimed include:
- Saver’s credit
- Lifetime learning credit (LLC)
- Adoption credit
- Foreign tax credit (FTC)
- Elderly and disabled credit
- Credit for residential energy-efficient properties
- General business credit(GBC)
- Credit for alternative vehicles
- Credit for tax credit bond holders
Some non-refundable tax credits, such as the general business credit (GBC) and foreign tax credit (FTC), let taxpayers to carry any unused amounts back to a previous year and forward to future tax years.
However, time constraints apply to the carryover regulations, which vary based on the credit. For example, although unused GBC amounts may be carried forward for up to 20 years, unused FTC amounts can only be carried forward for 10 years.
Pros and Cons of Non-Refundable Credits
If a taxpayer has both refundable and non-refundable tax credits, the advantages may be maximized by claiming non-refundable credits first. To reduce taxes owing, non-refundable tax credits should be utilized first. Only then should the refundable tax credits be utilized to further lower the tax burden until it reaches zero. If any refundable credits remain unutilized after the entire tax due has been fully offset, the taxpayer will be issued a refund check for the whole amount of unused credits.
However, claiming refundable credits first increases the likelihood that all refundable credits will be utilized to offset taxes payable, and any leftover non-refundable credits will only lower the tax owing to zero. Unused non-refundable credits will not be refunded to the taxpayer.
Low-income taxpayers are often unable to use the full amount of their non-refundable credits. Non-refundable tax credits are only applicable in the year they are earned; unused credits expire and cannot be rolled over to subsequent years. Non-refundable tax credits for the 2021 tax year include credits for adoption, energy-efficient residential property, and the saver’s tax credit for financing retirement funds.
What Is the Foreign Tax Credit?
The foreign tax credit (FTC) is a non-refundable benefit for US taxpayers with international income that reduces double taxation. Because all sources of income, domestic or foreign, must be taxed in the United States, the FTC credits portion of the foreign tax previously paid on the same revenue.
Can I Receive a Tax Refund if I Use a Non-Refundable Tax Credit?
Yes, however it will depend on how much tax withholding you have over the year. Non-refundable credits simply decrease the amount you owe in taxes; they do not compensate you if that amount falls below zero. However, if you had zero taxable income as a result of such credits and paid taxes monthly via payroll withholding, you will almost certainly get part or all of that back as a refund. The non-refundable credits cannot be utilized to produce a refund or to raise the amount you would otherwise get.
What Are Examples of Refundable Tax Credits?
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