What Is a Non-Refundable Tax Credit?
A non-refundable tax credit is a reduction in the amount of income taxes that a taxpayer owes, but it can reduce the amount owed to zero but no further. That is, the taxpayer forfeits any credit that exceeds the total amount of taxes owed.
By contrast, a refundable tax credit results in a refund from the Internal Revenue Service (IRS) if the credit reduces the taxpayer's liability to a number below zero.
Refundable and non-refundable tax credits are both directly subtracted from the amount of taxes that a taxpayer owes. Tax deductions, on the other hand, are subtracted from the taxpayer's taxable income. Tax credits generally result in bigger savings, especially for lower-income filers.
- A tax credit is a tax break that reduces a filer's tax liability dollar for dollar.
- A non-refundable tax credit can only reduce tax liability to zero.
- A refundable tax credit results in a tax refund if the amount owed is below zero.
- Examples of non-refundable credits in the U.S. tax code include the foreign tax credit and the saver’s credit.
How Non-Refundable Tax Credits Work
The U.S. tax code provides certain tax breaks in the form of tax credits that reduce the tax liability of eligible taxpayers. A tax credit is applied to the amount of tax owed by the taxpayer after all other allowable deductions are made from the person's taxable income.
A tax credit reduces the total tax bill of an individual dollar-for-dollar.
Refundable Credits vs. Non-Refundable Credits.
A tax credit can be either refundable or non-refundable. A refundable tax credit usually results in a refund check if the tax credit is more than the individual’s total tax liability.
For example, a taxpayer who applies a $3,400 refundable tax credit to a $3,000 tax bill will have the bill reduced to zero and the remaining portion of the credit—$400—will be refunded to the taxpayer.
A non-refundable tax credit does not result in a refund to the taxpayer, as it will only reduce the tax owed to zero.
Following the example above, if the $3,400 tax credit was non-refundable, the individual will owe nothing to the government but will forfeit the $400 that remains unused after the credit is applied.
Tax Deductions vs. Tax Credits
A tax deduction reduces the income subject to tax, but a tax credit reduces the amount of taxes that are owed on a dollar-for-dollar basis.
Which is the better benefit depends on the taxpayer’s marginal tax rate. If a taxpayer is entitled to a tax deduction of $100 and has a marginal tax rate of 30%, the deduction will save the taxpayer $30. If the same taxpayer is entitled to a tax credit of 50% of an expenditure of $100, the savings is $50. However, if the same taxpayer claims a tax credit for 20% of $100, the savings is only $20.
Tax Deductions Vs. Tax Credits
Unlike tax deductions which reduce taxable income, a tax credit reduces the amount of tax that you owe, dollar for dollar.
Examples of Non-Refundable Tax Credits
Commonly claimed tax credits that are non-refundable include:
- Saver's credit
- Lifetime learning credit (LLC)
- Adoption credit
- Foreign tax credit (FTC)
- Mortgage interest tax credit
- Elderly and disabled credit
- Residential energy efficient property credit
- General business credit (GBC)
- Alternative motor vehicle credit
- Credit for holders of tax credit bonds
Some non-refundable tax credits, such as the general business credit (GBC) and foreign tax credit (FTC) allow taxpayers to carry any unused amounts backward to a prior year and forward to future tax years.
However, time limits apply to the carryover rules and they differ depending on the specific credit. For example, while unused portions of the GBC may be carried forward up to 20 years, an individual can carry unused FTC amounts forward only up to ten years.
Strategies for Maximizing Non-Refundable Credits
If a taxpayer has both refundable and non-refundable tax credits, the benefits can be maximized by applying the non-refundable credits before claiming any refundable credits.
Non-refundable tax credits should be used first to minimize the taxes owed. Only then should the refundable tax credits be applied to reduce the tax liability even further to the point that the liability reaches zero. If any refundable credits are unused after the total tax liability is completely offset, the taxpayer will receive a refund check for the total amount of unused credits.
If the refundable credits were claimed first, there is a risk that all the refundable credits will be used to offset taxes due and any remaining non-refundable credits will only reduce the tax owed to zero. The unused non-refundable credits will not entitle the taxpayer to a refund.
Low-income taxpayers often are unable to use the entire amount of their non-refundable credits. Non-refundable tax credits are valid only in the year they are generated; they expire if unused and may not be carried over to future years.
For the 2022 tax year, specific examples of non-refundable tax credits include credits for adoption, for energy-efficient residential property, and the saver's tax credit for funding retirement accounts.
What Is the Foreign Tax Credit?
The foreign tax credit (FTC) is a non-refundable credit for U.S. taxpayers who have income overseas that minimizes double-taxation. Since American citizens must pay U.S. income tax on all sources of income, domestic or foreign, the FTC offsets some of the foreign tax already paid on the same income.
Can I Receive a Tax Refund If I Use a Non-Refundable Tax Credit?
Sure, you'll still receive the refund you qualify for, but it won't include a reimbursement for any unused portion of your non-refundable tax credlt.
It also depends on how much tax withholding you've had during the year. Non-refundable credits only reduce the amount you owe in taxes and do not pay you a refund if your tax bill goes to zero and the whole credit has not been used.
However, if you have zero taxable income due to such credits and you paid taxes monthly via payroll withholding, you will likely receive some or all of that back as a refund.
On their own, non-refundable credits cannot generate a refund or be used to increase the amount you would otherwise receive.
What Are Examples of Refundable Tax Credits?
Refundable tax credits are refunded to the taxpayer regardless of the taxpayer's liability. These include the earned income tax credit (EITC) and the additional child tax credit (ACTC).
The Bottom Line
Non-refundable tax credits can reduce a taxpayer's bill to zero, but no further. If the taxpayer owes less in taxes than the non-refundable credit is worth, they don't get reimbursed for the unusued credit. The opposite is true of a refundable credit.
Taxpayers entitled to both types of credits should apply their non-refundable credits first. Only then should they figure in refundable credits that could yield a refund.