A tax credit is a dollar-for-dollar amount a taxpayer can use to reduce the income tax they owe.
For example, John Smith has $100,000 of taxable income and owes $8,000 in income taxes. John has a $1,500 tax credit available. He can use the $1,500 to reduce his tax liability dollar for dollar. After accounting for the tax credit, John’s net tax liability is now $6,500 ($8,000 minus $1,500).
There are many tax credits available to U.S. taxpayers, which include, but are not limited to, the following credits:
- Earned Income Credit (EIC)
- Child Tax Credit (CTC)
- Child and Dependent Care Credit (CDCC)
- Low-Income Housing Credit (LIHCR)
- Lifetime Learning Credit
- Foreign Tax Credit
- Additional Child Tax Credit (ACTC)
- Clean Vehicle Credit
- General Business Credit
- Research and Development (R&D) Credits
From a U.S. federal tax perspective, tax credits are broadly characterized as either refundable or nonrefundable tax credits.
Refundable Tax Credits.
A refundable tax credit means taxpayers can claim a credit and obtain a refund even if the initial credit exceeds their tax liability.
For example, Jane Doe has $50,000 of taxable income and owes $1,500 in income taxes. She has a $2,000 child tax credit available. Jane uses the $2,000 credit to reduce her tax liability to zero ($1,500 of tax minus $1,500 worth of credit). After lowering her tax liability to zero, Jane has $500 of credit left over.
Because the child tax credit is refundable, she can claim the $500 unused amount. The IRS sends Jane a refund check for $500. If the tax credit were nonrefundable, Jane would not get a tax refund for the excess $500.
Nonrefundable Tax Credits
A nonrefundable tax credit means once a taxpayer’s tax liability is reduced to zero, the taxpayer won’t receive any leftover tax credit as a refund.
For example, John Smith has $80,000 of taxable income and owes $6,000 in income taxes. John purchased an electric vehicle in 2023 and has a $7,500 clean vehicle tax credit available.
John uses the $7,500 to offset his tax liability, reducing it from $6,000 to zero. John has a $1,500 remaining credit ($7,500 initial credit minus $6,000 tax).
Because this type of credit is nonrefundable, John lost the extra $1,500. He does not get a $1,500 refund, nor can he carry the credit over to a future tax year.
Additional Information
For more information on refundable and nonrefundable credits, taxpayers can visit the IRS website.