Unraveling Tax Credits: A Guide to Refundable and Non-Refundable Credits

The details of refundable and non-refundable tax credits can be confusing. But the difference between the two matters; they can have a direct on how much you owe or receive as a refund at tax time.

Tax Deductions vs Tax Credits:

Tax deductions reduce taxable income, lowering the amount subject to taxation. They include expenses like mortgage interest or charitable contributions. For example, if you have a $100 deduction, and you are in the 10% tax bracket, the deduction will save you $10.

Tax credits, on the other hand, directly reduce the amount of taxes owed. They are a dollar-for-dollar reduction in the actual tax liability and can be more valuable. While deductions influence the taxable income, credits impact the final tax bill, making them a more impactful way to lower the overall tax burden. That same $100, if a tax credit instead of a tax deduction, could save you $100.

Non-Refundable Tax Credits:

Non-refundable tax credits can help you lower your tax bill, but they won’t give you money back if they’re more than what you owe. They’re useful for things like education or childcare costs, making your tax situation more manageable. Some non-refundable tax credits for the 2023 tax year include:

• Child and dependent care credit – allows a credit of up to 35% of qualifying childcare costs to help parents be able to work or attend school. The credit is calculated on up to $3,000 of expenses for one qualifying child, and $6,000 for two or more children.

• Electric vehicle tax credit – Purchasing a qualifying vehicle could get you up to $7,500 for a new electric vehicle, or up to $4,000 for buying a used one.

• Residential clean energy tax credit – It is commonly known as the solar credit and can get you a credit of up to 30% of the cost of installing systems that use solar energy, such as solar panels, solar water heaters, and battery storage systems.

• Energy Efficient Home Improvement Credit – Available on the purchase of energy-saving items, this credit could save you up to $3,200 in taxes. Qualifying items include windows, doors, and heat pumps.

Refundable Tax Credits:

A refundable tax credit can give you a refund if it’s more than what you owe in taxes. Unlike non-refundable credits that just reduce your tax bill to zero, refundable credits can put money back in your pocket, even if you don’t owe any taxes. They’re especially helpful for low to moderate-income taxpayers.

• Earned income credit (EITC) – This credit aims to help lower and middle-income households remain in, or re-enter, the workforce. In tax year 2023, it provides a refundable credit between $600 and $7,430 to qualifying households. The amount is based on tax filing status, household income level, and (usually) the number of qualifying children. You do not have to have children to qualify, but having children in the household often leads to a higher credit amount.

Partly Refundable Tax Credits:

Partly refundable tax credits blend features of refundable and non-refundable credits. While they lower tax liability similar to non-refundable credits, they also have a limited refundable part. If the credit exceeds owed taxes, only a portion may be refunded, with the rest non-refundable. This category offers a balanced mix of immediate relief and potential refunds, providing taxpayers with a flexible approach to tax benefits. Notable partly refundable credits include:

• Child tax credit – up to $2,000 per qualifying child, with $1,600 potentially being refundable by using the additional child tax credit.

• American Opportunity Credit (AOTC) – this credit can be up to $2,500 for qualifying expenses for the first four years of college. If your tax liability is zero, up to $1,000 can be refundable.

Non-refundable, refundable, and partly refundable tax credits can be important tools used to lower your tax liability and could potentially increase your tax refund. The credits mentioned above are just a few of the available credits and the explanation is greatly simplified. Please consult with your tax professional to determine whether you qualify to use the credits, and how they can be used to your advantage.