What Is a Non-Refundable Tax Credit?
A non-refundable tax credit is a tax credit that can only reduce a taxpayer’s
liability zero. Generally, the amount of a non-refundable credit that exceeds a taxpayer’s liability is automatically forfeited by the taxpayer.
A non-refundable can be compared with refundable tax credits, which are generally more beneficial for taxpayers with little or no tax liability.
- A non-refundable tax credit is a type of income tax break that reduces tax liability dollar for dollar.
- A non-refundable tax credit can only reduce tax liability down to zero.
- A non-refundable tax credit does not reduce a taxpayer's taxable income; instead, it is net directly against the tax owed.
- Unlike a refundable credit, a non-refundable credit will not generate a tax refund if the amount of the credit exceeds the tax liability.
- Examples of non-refundable credits in the U.S. tax code include the foreign tax credit and the saver’s credit, among others.
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
deductions are made from his or her taxable income. A tax credit reduces the total tax bill of an individual dollar-for-dollar.
Refundable 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. 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, which is refunded to the taxpayer.
On the other hand, 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 also forfeit the amount of $400 that remains unused after the credit is applied.
Tax Deductions vs. Tax Credits
If an individual owes $3,000 to the government and is eligible for a $1,100 tax credit, he will have to pay only $1,900 after the credit is applied. A tax deduction of $1,100 reduces a taxpayer’s
taxable income by that same $1,100 amount.
Whether a tax credit or tax deduction provides the greater benefit to a taxpayer depends on the taxpayer’s marginal tax rate. If a taxpayer is entitled to a 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)
- 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; 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.
Pros and Cons of Non-Refundable Credits
If a taxpayer has both refundable and non-refundable tax credits, the benefits can be maximized by applying 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.
However, if refundable credits are 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 be entitled 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 2021 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, but this will depend 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 money if that amount goes to zero. But, 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. The non-refundable credits cannot generate a refund on their own or be used to increase the amount you would otherwise receive.
What Are Examples of Refundable Tax Credits?