Non-Refundable Tax Credit: Definition & Overview

KEY TAKEAWAYS

• A non-refundable tax credit is a certain type of tax break an individual can get on their income. It helps lower or eliminate the income tax liability. 
• Non-refundable tax credits are only able to reduce a tax liability to zero.
• If a non-refundable credit exceeds the tax liability it will not generate a tax refund. A refundable tax credit, on the other hand, will provide a refund. 
• Some common examples of non-refundable tax credits include the saver’s credit and the foreign tax credit. 

What Is a Non-Refundable Tax Credit?

Non-refundable tax credits are a type of credit that gets applied to certain tax deductions. The credit can only reduce a taxpayer’s total liability to zero. Basically, a non-refundable tax credit cannot get refunded to the taxpayer or create an overpayment. 

Any amount that exceeds the taxpayer’s income tax is lost. Some non-refundable credits, however, such as the foreign tax credit, are subject to carryover provisions. The excess credit can be carried back or forward to another tax year. In the case of refundable tax credits, they are fully refunded back to the taxpayer even if they exceed the tax due.

Taxpayers often receive more benefits through refundable tax credits compared to non-refundable credits. However, a lot depends on certain itemized deductions and taxable income. 

What Are the Types of Non-Refundable Tax Credits?

There are few non-refundable tax credits that allow taxpayers to carry unused amounts back or forward. These include the foreign tax credit (FTC) and the general business credit (GBC). However, certain carryover rules apply and depend on the specific type of credit. 

Here are some of the most common examples of non-refundable tax credits:

• Alternative motor vehicle credit
• General business credit (GBC)
• Residential energy efficient property credit 
• Credit for holders of tax credit bonds 
• Adoption tax credit 
• Foreign tax credit (FTC)
• Savers credit
• Lifetime learning credit (LLC)
• Premium tax credit
• Federal business credit 
• Efficient Property Tax Credit 
• Franchise tax credit 
• Renewable energy tax credit 
• Child care credit
• And other additional tax credits

How Do Non-Refundable Tax Credits Work?

There are various types of tax breaks that the U.S. tax code outlines. These breaks come in the form of tax credits and they’re intended to help reduce a taxpayer’s actual taxes. Tax credits are applied to the overall amount of tax an individual owes after deductions and other adjustments to taxable income. It’s also worth highlighting that a tax credit reduces the tax bill dollar-for-dollar. 

Refundable Tax Credits vs. Non-Refundable Tax Credits 

Tax credits come in two different forms and are based on your marginal tax rate: refundable and non-refundable.When you qualify for a refundable tax credit, it may generate a tax overpayment and result in a refund. However, this only happens if the tax credit amount is more than your total tax liability. 

On the flip side, non-refundable tax credits don’t provide you with any form of refund. This is because the non-refundable tax credit reduces the amount of tax that’s owed to zero. Common refundable tax credits include the child tax credit and the earned income tax credit (EITC). 

Example of Non-Refundable Tax Credits

Consider a scenario in which a person with one dependent earns $5,000 from a job and $1,000   from an investment income. The amount of federal income taxes withheld is $389.

Their AGI is $6,000.

Their marginal tax bracket is 10% and their effective tax bracket is 0%

After the standard deduction, their income tax due would be 0.

They claim a $500 American opportunity credit ($300 of which is non-refundable).

Additionally, based on their income level, they qualify for a refundable earned income credit of $560 and additional child tax credit of $375. After credits and payments, their tax refund would be $1,524.

Summary

Non-refundable tax credits are credits that a taxpayer can receive and use towards taxes payable. However, the credits can only reduce the taxpayer’s total liability to  zero. Basically, any excess credit cannot be refunded back to the taxpayer and it doesn’t matter how many sources of income there are. 

Some of the most common types of non-refundable tax credits include the foreign tax credit (FTC) and the general business credit (GBC). Non-refundable tax credits work in the opposite way of refundable tax credits. With refundable tax credits, the taxpayer will receive a full refund of the additional credit amount. 

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.