Federal tax credits are classified as either refundable or non-refundable. In most cases, a taxpayer is eligible to claim credits from either class, as long as he is eligible to take each credit he claims. While each credit provides a benefit in theory, depending on specific circumstances, non-refundable credits may not be as beneficial as refundable credits.
Non-refundable credits reduce the tax on your income, but not below zero. This means you may claim any non-refundable credit you’re eligible to claim until you owe zero tax. If your tax is reduced to zero and you still have credit remaining on your non-refundable credit calculation, you may not receive a refund for the difference and the remainder is not carried forward or back to other tax years. The zero tax calculation only applies to income tax, and does not apply to additional taxes you may owe for self-employment or early retirement plan distributions.
Types of Non-refundable Credits
There are more non-refundable credits than there are refundable credits. Some common child-related non-refundable tax credits include the child care tax credit, a portion of the child tax credit and certain education credits. An adult may also be eligible to claim an education credit. In addition, credit for foreign tax paid, retirement savings contributions and residential energy improvements are also non-refundable.
Refundable credits are credits that you receive 100 percent of, even if you owe zero tax. Refundable credits are the items that create refunds for taxpayers. Taxpayers often forfeit tax refunds by not filing a tax return. If you are not required to file a tax return because your income is too low, consider filing to claim the refundable credit you’re eligible to take.
Types of Refundable Credits
Examples of refundable credits include the earned income credit, additional child tax credit and income tax withholding credit, which is the amount of income tax your employer withholds from your paycheck. In addition to these regular refundable credits, the IRS periodically introduces new refundable credits. These refundable credits are generally granted through legislation and are not expected to remain permanent tax credits. Examples of special credits include the Making Work Pay tax credit, the refundable American opportunity education credit and the first-time homebuyer credit.
With a background in taxation and financial consulting, Alia Nikolakopulos has over a decade of experience resolving tax and finance issues. She is an IRS Enrolled Agent and has been a writer for these topics since 2010. Nikolakopulos is pursuing Bachelor of Science in accounting at the Metropolitan State University of Denver.