Contributed by: MatthewD, FreeTaxUSA Agent, Tax Pro
To save energy costs, you did some upgrades to your house this year by upgrading your air conditioner, windows, and doors. When you filed your return, you applied for an energy-efficient home improvement credit. However, you did not see a significant refund and wondered why. Keep in mind, certain tax credits may not directly affect your refund. We’ll discuss the difference between refundable and non-refundable tax credits and how they impact your tax return, refund, and tax due.
Nonrefundable Credits:
- May reduce your tax liability to zero but won't result in a tax refund if the credit amount exceeds your tax bill.
- The maximum benefit from a nonrefundable credit is capped at the amount of income tax you owe.
- If a non-refundable credit is larger than your tax liability, the unused portion of the credit is generally lost, although in some cases it can be carried forward to future tax years.
Refundable Credits:
- Are treated like a payment of taxes.
- Can reduce your tax liability below zero, potentially resulting in a tax refund even if you don't owe any tax.
- If a refundable credit amount is greater than tax you owe, the difference is paid to you as a refund.
- Taxpayers may still want to file a tax return even if they don't have a filing requirement to claim refundable tax credits and receive a refund.
In Simple Terms:
- Nonrefundable credits = Can reduce your tax bill to zero, but no money back from the credit itself.
- Refundable credits = Can reduce your tax bill to zero AND you can get a refund for any amount exceeding your tax liability.
Examples of common non-refundable and refundable credits:
Non-refundable credits:
- Energy Efficient Home Improvement Credit
- Electric Vehicle Credit
- Child Tax Credit
- Child and Dependent Care Credit
- Saver's credit (Retirement Savings Contributions Credit)
- Lifetime Learning Credit (Education Credit)
Refundable credits:
- Earned Income Tax Credit (EIC)
- Additional Child Tax Credit (ACTC)
- American Opportunity Tax Credit (AOTC)
Let’s look at an example of a return with non-refundable and refundable credits and how they impact the refund.
First, we’ll look at the “Tax and Credits” section. This section will show your total tax on line 24 after subtracting non-refundable credits. Line 16 (and 18) shows tax of $1,413. Next, line 19 shows the Child Tax Credit from Form 8812 of $725. If you look at Form 8812, the total credit is $2,000. However, there is a Credit Limit Worksheet which is applied and limits the credit to $725, since tax can’t be reduced below $0. The upside to the limitation on this credit is the balance is used to calculate the refundable Additional Child Tax Credit.
Second, line 20 has $688 in additional non-refundable credits from Schedule 3. They include the “Credit for Child and Dependent Care” and the “Retirement Savings Contribution” credit.
Note: The total credit on Line 21 is $1,413 and reduces the total tax to $0 on Line 22. With a total tax of $0, payments in the next section can be refunded.
Finally, let’s look at the “Payments” section where refundable credits along with withholdings from W-2's, 1099’s, and estimated payments are listed.
Line 25a reports W-2 federal withholdings. In our example, the amount is $3,600. Line 27 lists one of the most common refundable credits, the “Earned Income Credit (EIC). Line 28 reports the “Additional Child Tax Credit” from Form 8812. These two credits total $3,362. Adding $3,600 in withholdings, this example has a refund total of $6,962.
Conclusion
As you prepare your return each year, keep in mind that a nonrefundable credit can never be more than your tax on line 18. It will lower taxes and often increase a refund. Sometimes if you are unable to use a credit, it may be carried forward to the next year. Not all non-refundable credits can be carried forward, and you must use them or lose them.
Refundable credits are considered tax payments. Therefore, even if your total tax liability is zero, it is advisable to file a tax return to claim refundable credits and receive a tax refund.