Non-Refundable Tax Credit

A non-refundable tax credit is a tax credit that can only reduce a taxpayer’s liability to zero. Any amount that remains from the credit is automatically forfeited by the taxpayer.

Also referred to as a wastable tax credit.

The government provides certain tax breaks in the form of tax credits to reduce the tax liability of its taxpayers. A tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from his or her taxable income, and reduces the total tax bill of an individual dollar to dollar. If an individual owes $3,000 to the government, and is eligible for a $1,100 tax credit, he will only have to pay $1,900 after the credit is applied. A tax credit can be either refundable or non-refundable. A refundable tax credit usually results in a refund check if the tax credit is more than the individual’s total tax liability. A taxpayer who applies a $3,400 tax credit to his $3,000 tax bill will have his bill reduced to zero, and the remaining portion of the credit, that is $400, refunded to him.

On the other hand, a non-refundable tax credit does not result in refund to the taxpayer as it will only reduce the tax owed to zero. Following the example above, if the $3,400 tax credit was non-refundable, the individual will owe nothing to the government, but will also forfeit the amount of $400 that remains after the credit is applied.

The most commonly claimed tax credits are non-refundable. Examples are:

• The Saver's Credit
• Lifetime Learning Credit (LLC)
• Adoption Credit
• Child and Dependent Care Credit
• Foreign Tax Credit (FTC)
• Mortgage Interest Tax Credit
• Elderly and Disabled Credit
• Residential Energy Efficient Property Credit
• General Business Credit (GBC)
• Alternative Motor Vehicle Credit
• Credit to holders of tax credit bonds

Some non-refundable tax credits, such as the general business credit and foreign tax credit, allow taxpayers to carry any unused amounts forward to future tax years. However, there are time limits applied to the carryover rules. For example, while unused portions of the GBC may be carried forward up to 20 years, an individual can only carry FTC unused amounts forward up to five years.

A taxpayer who has both refundable and non-refundable tax credits can maximize his total credit potential if he calculates his non-refundable credits before applying his qualified refundable credits. Non-refundable tax credits should be used first to minimize the taxes owed. Only after should the refundable tax credits be applied to reduce the minimized amount even further so that if it falls below zero, if the tax liability becomes negative, the individual will receive a refund check for the total amount below zero. If he files his taxes in reverse order, he will use up all his refundable credit and the non-refundable will only reduce his tax owed to zero, nothing less.