There are two types of tax credits available to taxpayers − refundable and non-refundable.
With non-refundable tax credits, the amount of the credit you're entitled to claim is subtracted from your tax liability, up to the amount of taxes you owe. For example, if your total tax liability is $2,000, and you qualify for $3,000 of the Child and Dependent Care Credit, you can only claim $2,000 of the credit (the amount of your tax liability). The $1,000 that remains is not refundable. Some unused credits can be carried forward to future years, and many other unused credits are lost and not allowed to be carried forward.
Other examples of non-refundable tax credits include:
- Lifetime Learning Credit
- Adoption Credit
- Foreign Tax Credit
- The Saver’s Credit
- Elderly and Disabled Credit
- Child Tax Credit
Refundable credits work exactly like non-refundable credits except any excess amount is eligible for refund. For example, if your tax liability is $2,400 and you qualify for EITC in the amount of $3,461, you would be eligible to receive a refund of $1,061.
Other examples of refundable tax credits are:
- American Opportunity Tax Credit (40% refundable)
- Premium Tax Credit
- Additional Child Tax Credit (up to $1,400 of the $2,000 per child)
- Earned Income Tax Credit (EITC) as referenced in the example above.
In summary, a non-refundable credit can reduce your tax liability to zero, and a refundable credit can give you money back when the amount of the credit is more than the amount you owe.