What is a tax credit?

Tax credits are an amount of money that taxpayers can subtract from their tax bill. One dollar of tax credits equals one dollar subtracted from your bill for the current tax year. Tax credits are more favorable than tax deductions or exemptions because tax credits reduce tax liability dollar for dollar.

Individuals and business have certain kinds of tax credits depending on location, classifications, and industries.

Tax credits might be promoted to persuade action or change such as a credit for adding solar energy panels to a house to help boost greener energy. They also may be granted to help ease the burden on housing and other costs for lower-income taxpayers.

There are three basic types of tax credits: nonrefundable, refundable, and partially refundable.

Nonrefundable tax credits

A nonrefundable tax credit means that a taxpayer will not get a refund if the balance due for taxes zeros out. They can only help reduce the tax bill. The remaining part of a nonrefundable tax credit that can’t be utilized is lost.

Nonrefundable tax credits are only valid in the year of reporting. They expire after the return is filed and may not be carried over to future years.

Example of nonrefundable tax credits are:

• Adoption
• the Child and Dependent Care Credit
• the Saver’s Tax Credit for funding retirement accounts
• mortgage interest credit

Refundable tax credits

A refundable tax credit is when a taxpayer receives payment for the credit. This means that a taxpayer—regardless of their income or tax liability—is entitled to the entire amount of the credit. If the credit reduces the tax liability to below $0, the taxpayer will receive a refund.

Examples of refundable tax credits:

• Earned income tax credit (EIC)
• Premium tax credit

Partially refundable tax credits

If a tax credit is partially refundable that means it can both decrease taxable income and lower tax liability. If a taxpayer amount owed is reduced to $0 before using the entire credit amount, they may either take a refund of a certain percentage of the remaining amount or a fixed amount.

Examples of partially refundable tax credits:

• The Child Tax Credit
• American Opportunity Tax Credit (AOTC) for post-secondary education students

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