What is the Difference Between Refundable and Non-refundable Tax Credit?
Tax season is in full swing, and many people misinterpret the refundable and non-refundable tax credit. What is the difference between refundable and non-refundable tax credits? And which one is better? Keep reading to find out.
Tax credits are a vital part of the U.S. tax system, and there are two main types: refundable and non-refundable. Understanding the difference between these two types is important for taxpayers, as it can impact how much money they receive back on their taxes.
In this blog post, we will break down the differences between these two types of Credits so that you can understand the difference when speaking to your tax accountant or evaluating your tax return.
What does non-refundable tax credit mean?
A Non Refundable Tax Credit is a credit that reduces your liability to zero; if anything remains after applying the credit to your tax liability, the remaining amount will automatically become forfeited.
In other words, if you don’t owe any taxes, then you can’t get a refund for the unused portion of the credit.
Let’s dig into an example of how non-refundable tax credit works.
Say you owe $800 in taxes, and you have a $1000 non-refundable tax credit. The $1000 tax credit will reduce your tax bill by $800, but you won’t get a refund for the remaining $200.
Let’s dig deeper!
Non-refundable tax credit examples
Non-refundable tax credits can help lighten your financial obligation during tax time. You can take advantage of these valuable credits and save money.
There are several non-refundable tax credits available, so be sure to explore all of your options.
Let’s look at a few below:
- Mortgage Interest Tax Credit (Calculate this credit on Form 8396)
- Foreign Tax Credit (Use form 1116 to calculate credit)
- Lifetime Learning Credit (To calculate credit use form 8863)
- Other Dependent Credit (Use worksheet Wks 8812 for credit calculation)
- Minimum Tax Credit (Calculated on form 8801)
- Retirement Savings Opportunity Credits (Use form 8880 to calculate credit)
- Credit for the Elderly or Disabled (Use Schedule R to calculate credit)
What does refundable tax credit mean?
Refundable tax credits are credits that can reduce your tax liability and provide a refund for the remaining amount.
The Earned Income Tax Credit, for example, is a refundable tax credit that can result in a larger refund than the amount of tax paid throughout the year.
This will result in a negative tax liability. Meaning, you can receive a refund for the unused portion of the credit. So, even if you don’t owe any taxes, you can still get a refund for the total amount of the credit.
How does the refundable tax credit work?
Let’s say that you have a $1200 refundable tax credit, but you only owe $800 in taxes. The refundable tax credit will give you a refund of $400. That’s $1200 – $800.
Another example would be paying a $0 tax liability and receiving a $2000 credit. In other words, because you did not owe any taxes, your refunded amount from the credit will be the full $2000.
Refundable tax credit Examples
Save money on your taxes by reducing the amount of taxable income you’ll owe and receive a refund on the excess amount.
Check out a few refundable tax credits below:
- Net Premium Tax Credit (Calculate by using form 8962)
- Additional Child Tax Credit (Use form 8812 to calculate credit)
- Earned Income Tax Credit (To calculate credit, use EIC)
- Credit on Federal Tax paid on Fuel (Use form 4136 to calculate this credit)
- Child Tax Credit (Use form 8812)
- American Opportunity credit (To calculate use form 8863)
- Health Coverage Tax Credit (This credit is calculated on form 8885)
Critical Differences Between Non-refundable And Refundable Tax Credit.
There are a few key differences between these two types of credits, which we will outline below.
Amount of the Credit
The refundable credit amount can provide a higher value than the non-refundable credit. This is because the refundable credit is used to its full potential to offset any taxes that you owe and receive the excess as a refund.
In contrast, you can only use the non-refundable credit to reduce your tax bill, which will be capped at a taxpayer’s liability.
How tax credits are Paid Out?
The refundable credit is usually paid out as a refund, while the non-refundable credit is generally deducted from your taxes when you file.
When is it Claimed?
The refundable tax credit can be claimed at any time, even if you don’t owe any taxes. The non-refundable tax credit will only affect tax liability.
What Happens if You Don’t Use It?
If you don’t use the total amount of the refundable tax credit, you will get a refund for the unused portion. If you don’t use the total amount of the non-refundable tax credit, you won’t get a refund for the unused portion.
How It’s Calculated
The refundable tax credit is usually calculated based on your income and filing status, while the non-refundable tax credit is based on your total taxable income.
Which One Is Better
There is no one-size-fits-all answer to this question since the best credit will depend on your situation. However, refundable credit tends to be more beneficial for most taxpayers.
What It’s Used For
You can use the refundable tax credit for various purposes outside of your tax return, such as paying child care or college expenses. The non-refundable tax credit is only used to reduce your taxable income.
How It Affects Your Taxes
The refundable Tax Credit can positively affect your taxes, meaning you’ll get more than what you owe, while the non-refundable tax credit will not.
It’s no secret that tax season can be confusing and overwhelming, and it can be tough to determine which ones qualify with all the other tax credits and deductions available. Two of the most common tax credits are refundable and non-refundable tax credits.
So, what’s the difference?
In short, a refundable tax credit is one that you can receive even if you have no tax liability. That’s a credit that can offset any tax liability you may have, and if the credit exceeds your tax liability, the excess is refunded to you.
It’s literally like getting money from the government! There are several additional refundable tax credits available, depending on your situation.
A non-refundable tax credit, on the other hand, is only worth anything if you have enough taxes owed to offset it. This credit reduces your tax liability on a dollar-for-dollar basis, and the excess amount will not be refunded to you.
If you need help determining which tax credits you qualify for, check out my service page or schedule a consultation here.
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