It’s my annual “Taxes from A to Z” series! Next up:
A credit is a dollar for dollar reduction in the amount of tax you owe. There are two types of tax credits:
A refundable tax credit can reduce your tax liability below zero. If the amount of the refundable credit is larger than the amount of tax you owe, you are due a tax refund. With a refundable tax credit, you can get a tax refund even if you didn’t have any tax obligation and even if you didn’t pay into the system. Popular refundable tax credits include the American Opportunity Tax Credit (up to 40% refundable), Premium Tax Credit (Affordable Care Act) and the Earned Income Tax Credit (EITC).
In contrast, a nonrefundable tax credit means you get a refund only up to the amount you owe for taxes. With a nonrefundable tax credit, a taxpayer can only reduce tax liability to zero: there is no refund for excess nonrefundable credit. This is the most common type of tax credit.
You’ll find most of the nonrefundable tax credits listed on the form 1040 on page two. They include:
- Foreign tax credit
- Credit for child and dependent care expenses
- Education credits (the Lifetime Learning credit and part of the American Opportunity credit)
- Retirement savings contributions credit (the “saver’s credit”)
- Child tax credit
- Residential energy credits
A few nonrefundable tax credits which aren’t specifically listed on page two of the 1040 are the Adoption credit, credit for the elderly or the disabled and the mortgage interest credit (a special credit for certain lower-income individuals).