Definition, How It Works, and Benefits

What Is a Non-Refundable Tax Credit score?

A non-refundable tax credit score is a tax credit score that may cut back a taxpayer’s legal responsibility solely to zero. Usually, the quantity of a non-refundable credit score that exceeds a taxpayer’s legal responsibility is robotically forfeited by the taxpayer. For taxpayers with little or no tax legal responsibility, refundable tax credit usually are extra useful than non-refundable tax credit.

A non-refundable will be in contrast with refundable tax credit, that are usually extra useful for taxpayers with little or no tax legal responsibility.

Key Takeaways

  • A non-refundable tax credit score is a sort of revenue tax break that reduces tax legal responsibility greenback for greenback.
  • A non-refundable tax credit score can solely cut back tax legal responsibility all the way down to zero.
  • Not like a refundable credit score, a non-refundable credit score is not going to generate a tax refund if the quantity of the credit score exceeds the tax legal responsibility.
  • Examples of non-refundable credit within the U.S. tax code embody the international tax credit score and the saver’s credit score, amongst others.

How Non-Refundable Tax Credit Work

The U.S. tax code offers sure tax breaks within the type of tax credit that cut back the tax legal responsibility of eligible taxpayers. A tax credit score is utilized to the quantity of tax owed by the taxpayer in any case deductions are made out of their taxable revenue. A tax credit score reduces the full tax invoice of a person dollar-for-dollar.

Refundable Credit vs. Non-Refundable Credit.

A tax credit score will be both refundable or non-refundable. A refundable tax credit score often leads to a refund verify if the tax credit score is greater than the person’s complete tax legal responsibility. A taxpayer who applies a $3,400 refundable tax credit score to a $3,000 tax invoice could have the invoice diminished to zero. The remaining portion of the credit score—$400—is refunded to the taxpayer.

Then again, a non-refundable tax credit score doesn’t end in a refund to the taxpayer, as it can solely cut back the tax owed to zero. Following the instance above, if the $3,400 tax credit score was non-refundable, the person will owe nothing to the federal government, however may also forfeit the quantity of $400 that continues to be unused after the credit score is utilized.

Tax Deductions vs. Tax Credit

Not like a tax deduction, which reduces the revenue topic to tax, a tax credit score reduces the quantity of taxes that you simply owe, on a dollar-for-dollar foundation.

Whether or not a tax credit score or tax deduction offers the better profit to a taxpayer relies on the taxpayer’s marginal tax charge.  If a taxpayer is entitled to a tax deduction of $100 and has a marginal tax charge of 30%, the deduction will save the taxpayer $30.  If the identical taxpayer is entitled to
a tax credit score of fifty% of an expenditure of $100, the financial savings is $50. Nevertheless, if the identical taxpayer claims a tax credit score for 20% of $100, the financial savings is just $20.     

Tax Deductions Vs. Tax Credit

Not like tax deductions which cut back taxable revenue, a tax credit score reduces the quantity of tax that you simply owe, greenback for greenback.

Examples of Non-Refundable Tax Credit

Generally claimed tax credit which might be non-refundable embody:

Some non-refundable tax credit, equivalent to the final enterprise credit score (GBC)  and international tax credit score (FTC) permit taxpayers to hold any unused quantities backward to a previous yr and ahead to future tax years.

Nevertheless, closing dates apply to the carryover guidelines; they differ relying on the precise credit score. For instance, whereas unused parts of the GBC could also be carried ahead as much as 20 years, a person can carry unused FTC quantities ahead solely as much as ten years.

Methods for Maximizing Non-Refundable Credit

If a taxpayer has each refundable and non-refundable tax credit, the advantages will be maximized by making use of their non-refundable credit earlier than claiming any refundable credit. Non-refundable tax credit needs to be used first to reduce the taxes owed. Solely then ought to the refundable tax credit be utilized to cut back the tax legal responsibility even additional to the purpose that the legal responsibility reaches zero. If any refundable credit are unused after the full tax legal responsibility is totally offset, the taxpayer will obtain a refund verify for the full quantity of unused credit.

Nevertheless, if refundable credit are claimed first, there’s a danger that every one the refundable credit will probably be used to offset taxes due and any remaining non-refundable credit will solely cut back the tax owed to zero. The unused non-refundable credit is not going to entitle the taxpayer to a refund.  

Low-income taxpayers usually are unable to make use of the whole quantity of their non-refundable credit. Non-refundable tax credit are legitimate solely within the yr they’re generated; they expire if unused and will not be carried over to future years. For the 2022 tax yr, particular examples of non-refundable tax credit embody credit for adoption, for energy-efficient residential property, and the saver’s tax credit score for funding retirement accounts. 

What Is the Overseas Tax Credit score?

The international tax credit score (FTC) is a non-refundable credit score for U.S. taxpayers who’ve revenue abroad that minimizes double-taxation. Since Americans should pay U.S. revenue tax on all sources of revenue, home or international, the FTC offsets among the international tax already paid on the identical revenue.

Can I Obtain a Tax Refund If I Use a Non-Refundable Tax Credit score?

Positive, however it will rely upon how a lot tax withholding you have had through the yr. Non-refundable credit solely cut back the quantity you owe in taxes, and don’t pay you a refund in case your tax invoice goes to zero and the entire credit score has not been used. Nevertheless, if in case you have zero taxable revenue as a result of such credit and also you paid taxes month-to-month by way of payroll withholding, you’ll probably obtain some or all of that again as a refund. On their very own, nevertheless, non-refundable credit can’t generate a refund or be used to extend the quantity you’d in any other case obtain.

What Are Examples of Refundable Tax Credit?

The Backside Line

Non-refundable tax credit cut back a taxpayer’s invoice solely to zero. If the taxpayer owes much less in taxes than the non-refundable credit score is price, they don’t get to gather the steadiness as a tax refund. The other is true of a refundable credit score. Taxpayers entitled to train each forms of credit ought to apply their non-refundable credit first. Solely then ought to they determine in refundable credit that might yield a refund

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