What Is a Nonrefundable Tax Credit?
A nonrefundable credit reduces the federal tax a taxpayer owes but does not result in a refund if the credit exceeds the tax liability.
For example, if you owe the IRS $750 and qualify for a $1,000 nonrefundable credit, your taxes will be reduced to zero, but the remaining $250 from your credit will not be issued as a refund.
Some nonrefundable credits such as the General Business and Foreign Tax credits allow any leftover amount to be carried forward to pay future taxes or backward to settle tax debt.
In addition, the General Business Credit can be used by companies that invest in renewable energy or hire people from disadvantaged groups.
For example, a business that invests in renewable energy or hires veterans might be able to claim $50,000 as a General Business or Work Opportunity credit.
If the business’s annual tax liability is only $40,000, it can apply $40,000 of the credit to eliminate its tax liability.
The remaining $10,000 is nonrefundable but can be carried back one year to pay a tax debt or carried forward for up to 20 years to pay future taxes.
How Do Nonrefundable Credits Differ from Refundable Credits and Tax Deductions?
Refundable credits as the name implies can result in refunds. However, nonrefundable credits can only be used to lower or eliminate taxes.
In some situations, like the American Opportunity Tax Credit (AOTC), credits are partially refundable. Up to $1,000 of AOTC is refundable. A tax deduction, unlike a credit, lowers taxable income rather than directly offsets taxes owed.
For example, a $2,500 deduction reduces taxable income by that amount and can put you in a lower tax bracket, but a credit reduces the actual tax amount you have to pay by $2,500.
In general, credits benefit people earning less than $100,000, while deductions benefit taxpayers in higher tax brackets.
What Are Some Nonrefundable Tax Credit Examples?
The Child Care Credit (for children and dependent care expenses), Lifetime Learning Credit (for undergrad and graduate education expenses), the Foreign Tax Credit (for taxes paid to foreign governments), and the Adoption Credit (to offset adoption costs) are common nonrefundable tax credits.
Other nonrefundable tax credit programs include the Saver’s Credit (for retirement savings contributions) and the Residential Energy-Efficient Property Credit (for energy-efficient home improvements).
Child Care Credit Example
If you qualify for a 35% credit for childcare expenses for two children and spent $6,000, you can reduce your taxes by $2,100.
So, if you owe $1,500 you will owe $0 after the credit but will not get the remaining $600 of your credit as a refund.
If you owe $5,000 you will only owe $2,900 when you claim the credit.
Residential Energy Credit Example
If you spend $25,000 to install solar panels and can take the 30% energy credit, you can reduce your taxes by $7,500.
If you owe less than $7,500, you will owe $0 with the credit but will not get a refund for any credit that is left.
If you owe more than $7,500, you will subtract $7,500 from your total tax liability.
Who Is Eligible for Nonrefundable Tax Credits?
Different nonrefundable credits have different eligibility requirements to qualify.
As an example, nonrefundable tax credits like the Lifetime Learning Credit and Saver’s Credit (Retirement Savings Contributions Credit) have specific qualifying expenses or contributions and income limits.
To claim these credits, taxpayers must meet all IRS requirements, including income thresholds and life circumstances.
The Lifetime Learning Credit (LLC) for 2024 phases out at a Modified Adjusted Gross Income (MAGI) of between $80,000 and $90,000 for single filers and $160,000 to $180,000 for married filing jointly.
The Saver’s Credit offers a credit of 50% of your contribution for 2024 when your MAGI is less than $34,000 if you are filing as head of household and $46,000 for those married filing jointly.
General criteria for taking a nonrefundable tax credit include being a U.S. citizen, resident alien, or eligible nonresident alien, having income limitations, filing status, submitting dependent information, and providing W-2 forms or other documentation to support income eligibility.
For more specific nonrefundable tax credit criteria and to see if you qualify for any credits go to:
- Adoption Credit: https://irs.gov/taxtopics/tc607
- Child Care Credit: https://irs.gov/credits-deductions/individuals/child-and-dependent-care-credit-information
- Energy Efficient Home Improvement Credit: https://irs.gov/credits-deductions/energy-efficient-home-improvement-credit
- Foreign Tax Credit: https://irs.gov/individuals/international-taxpayers/foreign-tax-credit
- Lifetime Learning Credit: https://irs.gov/credits-deductions/individuals/llc
- Saver’s Credit: https://
How Do Nonrefundable Tax Credits Affect Your Tax Refund?
Nonrefundable tax credits do not directly increase refunds unless taxes are overpaid through withholding or estimated payments. They can reduce tax liability to zero, but unused portions are forfeited. If withholdings exceed a final tax liability, overpaid amounts may be refunded.
For example, if you claim a $2,000 nonrefundable Child Care Credit and owe $1,500 in back taxes, your full tax debt is eliminated since the credit exceeds your liability.
Keep in mind that you are not eligible for a $500 refund of the remaining credit because you did not overpay taxes.
However, if you had $500 withheld from your paychecks during the tax year, the IRS can refund you the $500 because you overpaid your taxes.
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