Can a non-refundable tax credit be used to negate an early withdraw penalty from Traditional IRA?

Question

I'm considering buying a new electric vehicle which would qualify for the US Federal Clean Vehicle Tax Credit.

In theory, I could be eligible for up to a $7500 tax credit.

My current paycheck tax witholdings usually result in an annual tax refund. I'd prefer to leave my paycheck withholding rate as it is.

I'm curious though: I have a traditional IRA. I understand that if I withdraw early from that (before age 59.5) the amount of money I withdraw would be subject to taxes and a 10% early withdrawal penalty.

My question: Can a non-refundable tax credit in the united states be used to negate the taxes/penalties owed from an early withdrawl of traditional IRA? Or do penalties need to be paid back regardless of whether or not someone has available credits?

Answer 1

The non-refundable vehicle tax ultimately ends up on Line 20 of the 1040.

The IRA early withdraw penalty ultimately ends up on Line 23 of the 1040 form.

In between those lines is the important line 22. If that value would be negative then you write zero in line 22. If it is positive it doesn't change.

Lets look at a couple of scenarios:

1. No vehicle credit, but IRA penalty. $6,000 before line 20. IRA penalty $5,000.

   The total tax is $6,000 + $5,000 or $11,000
   

2. Vehicle credit, but IRA penalty. $6,000 before line 20. Vehicle credit $7,500. IRA penalty $5,000.

   Line 22 will be zero, and the total tax will be $5,000. 
   You saved $6,000 instead of $7,500
   

3. More initial tax. No vehicle credit, but IRA penalty. $20,000 before line 20. IRA penalty $5,000.

   The total tax is $20,000 + $5,000 or $25,000
   

4. More initial tax. Vehicle credit, but IRA penalty. $20,000 before line 20. Vehicle credit $7,500. IRA penalty $5,000.

   Line 22 will be $12,500, and the total tax will be $17,500. You saved the full $7,500.

So if your income taxable income is low, you might not get the impact of the full credit. You have to decide if it makes sense.