Tax credits can reduce your tax bill or give you a bigger refund, but not all tax credits are created equal. While most tax credits are refundable, some credits are nonrefundable. Still, before we look at the difference between refundable and nonrefundable tax credits, it's important to understand the difference between a tax credit and a tax deduction.
Understanding the Difference between a Tax Credit and a Tax Deduction
Tax credits reduce your tax liability dollar for dollar and are more valuable than tax deductions that reduce your taxable income and are tied to your marginal tax bracket. Let's look at the difference between a tax credit of $1,000 and a tax deduction of $1,000 for a taxpayer whose income places them in the 22% tax bracket:
A tax credit worth $1,000 reduces the amount of tax owed by $1,000 - the same dollar amount.
A tax deduction worth the same amount ($1,000) only saves you $330, however (0.22 x $1,000 = $220). As you can see, tax credits save you more money than tax deductions.
Tax Credits: Refundable vs. Nonrefundable
A refundable tax credit reduces the federal tax you owe and could result in a refund if it is more than you owe. Let's say you are eligible for the Child Tax Credit for $1,000 but only owe $200 in taxes. The additional amount ($800) is treated as a refund.
A nonrefundable tax credit means you get a refund only up to the amount you owe. For example, if you are eligible to take an American Opportunity Tax Credit worth $1,000 and the amount of tax owed is only $800, you can only reduce your taxable amount by $800 - not the full $1,000.
Examples of Refundable Tax Credits
The Earned Income Tax Credit
Additional Child Tax Credit
Premium Tax Credit
Nonrefundable Tax Credits
Examples of nonrefundable tax credits include:
Adoption Tax Credit
Electric Vehicle Tax Credit
Foreign Tax Credit
Mortgage Interest Tax Credit
Residential Energy Property Credit
Credit for the Elderly or the Disabled
Credit for Other Dependents
The Saver's Credit
Partially Refundable Tax Credits
Some tax credits are only partially refundable such as:
Child Tax Credit (fully refundable in 2021 and 2022)
American Opportunity Tax Credit
Questions About Tax Credits or Deductions?
If you have any questions or want more information about these tax topics, please call.
| About Author |
|
Mr. Maker is a certified Public Accountant and serving the South Asian community since 1993.
|
Website: https://taxprofessionalsnw.com/newsletter.php#4
Disclaimer: Please use this channel at your own discretion. These articles are contributed by our users. We are not responsible or liable for any problems related to the utilization of information of these articles.
View All Contributions
|
