Tax credits in USA. A tax credit is an amount of money that taxpayers can subtract from taxes owed to their government. The value of a tax credit depends on the nature of the credit; certain types of tax credits are granted to individuals or businesses in specific locations, classifications or industries. Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed.

Tax credits are more favorable than tax deductions or exemptions because tax credits reduce tax liability dollar for dollar.

Refundable Tax Credits:

Tax credits in USA. Refundable tax credits are the most beneficial credit, as they are entirely refundable. This indicates that, regardless of a taxpayer’s income or tax liability, they are entitled to the entire amount of the credit. This is true even if the refundable tax credit reduces the tax liability below $0.

However, these credits are the most versatile type of tax credit. These credits are treated just like tax payments that you make to the IRS, such as income taxes withheld from your paycheck or estimated tax payments that you make throughout the year. In other words, a refundable credit is subtracted from the amount of taxes you owe, similar to the way the tax withheld from your paycheck is subtracted from your total yearly tax liability.

A refundable tax credit is particularly advantageous because it can reduce your tax liability to below zero. If the amount of a refundable tax credit is more than the amount of taxes due, the difference will be given back to you as a tax refund. If you are already owed a tax refund, the refundable credit will be added to increase the amount of your refund.

Some examples of refundable tax credits include:

  • Additional Child Tax Credit
  • Earned Income tax credit
  • Health Coverage Tax Credit
  • Small Business Health Care Tax Credit


Non-Refundable Tax Credits:

A nonrefundable credit is subtracted from your income tax liability, up to the total amount you owe. But unlike a refundable tax credit, a nonrefundable credit cannot reduce your tax balance beyond zero. However, any unused portion of a nonrefundable tax credit will expire in the year the credit is claimed and cannot be carried over.

Also, any excess nonrefundable tax credit is not utilized, as any amount that would potentially reduce the tax liability further is not paid out. Nonrefundable tax credits negatively impact low-income taxpayers, as they are often unable to use the entire amount of the credit. Nonrefundable tax credits are valid in the year of reporting only, expire after the return is filed, and may not be carried over to future years.

As of 2018, specific examples of nonrefundable tax credits include credits for adoption, non-child dependents, paying foreign taxes and paying mortgage interest.

Some examples of refundable tax credits include,

  • Adoption Tax Credit
  • Child Tax Credit
  • Foreign Tax Credit
  • Mortgage Interest Tax Credit


Partially Refundable Tax Credits:

Tax credits in USA. Certain tax credits are considered partially refundable because they fit into both categories. In these cases, only a portion of the tax credit can be refunded to you. This type of credit is a bit more complicated — it can be subtracted from the amount of taxes owed and applied to increase the tax refund.

The American Opportunity Tax Credit is an example of a partially refundable credit.

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