3

I'm in the United States. The Child Tax Credit is a non-refundable credit of $1000.

Scenario 1 : I do my taxes at the end of the year and before applying the credit I owe $1000, then presumably after the credit I owe $0.

Scenario 2 : I do my taxes at the end of the year and before applying the credit I owe $0. Do I now get a refund of $0? Or in this scenario, does the $1000 apply to the amount I had to pay in that year, regardless of how much I have already paid. In that case in scanario 2 - assuming I paid in at least $1000 of taxes that year - my refund would be bumped to $1000.

In other words, should I try to carefully make it so that at the end of the year I have a balance due to the IRS of value equal to at least the sum of all non-refundable credits I am due? Or does it all come out in the wash?

  • When did the child tax credit become non-refundable? – Kevin Jan 28 '18 at 0:47
  • @Kevin think it has been for a while. I have somehow missed this over the years, but it seems to be true nonetheless. See here : turbotax.intuit.com/tax-tips/family/… for an example of an article that it says it's non-refundable. – Josh Brown Kramer Jan 28 '18 at 1:31
  • From your link: "However, you may be able to claim a refundable Additional Child Tax Credit for the unused balance. You can find out if you're eligible for this refundable credit by completing the worksheet in IRS Form 8812." This may explain both why the basic credit is not refundable but people have the impression that it is. – Brythan Jan 28 '18 at 3:24
13

A tax refund (or additional amount owed) is the difference between the tax you owe and what was already paid (via withholding or estimated quarterly payments). A tax credit reduces the amount of tax you owe regardless of how much was withheld. Altering withholding would not change the benefit from the tax credit.

Say you make $35,000, are single and take the standard deduction. Based on your income, filing status, and deductions, you owe $3,224 in federal income tax. If you have a $1,000 tax credit, that means you owe $2,224. That number is unaffected by withholding. So if you had $3,000 withheld you'd get a refund of $776, if you had $2,000 withheld you'd owe an additional $224, either way you benefit from the tax credit.

Some people like getting a big refund, but a big refund just means you had access to less of your money throughout the year (unless refundable credits are involved). Some people like owing a bit at tax-time, since that means they had access to more of their money throughout the year. Our taxes are 'pay as you earn' so there are penalties if you didn't pay enough throughout the year.

The type of credit is immaterial to your question, they all offset your tax liability and how much you had withheld doesn't impact their benefit. The difference between a non-refundable tax credit and refundable is that non-refundable credits can only bring your tax liability to $0, meaning the maximum refund you could get is the total of what you had withheld (or paid in quarterly estimates). Refundable credits can basically drive your tax liability into the negative, thus potentially giving you a refund greater than the amount of federal income tax that was withheld. So, you could waste some of a non-refundable credit by not having enough tax liability to benefit from it entirely.

With refundable credits, some people do try to game the system to maximize benefit by keeping their income below a threshold, it's not a prudent strategy in general to deliberately earn less in an effort to save on taxes, it usually stems from a misunderstanding of how our tax system works.

  • This answer doesn't seem to take nonrefundable credits into account. – RonJohn Jan 27 '18 at 21:41
  • 1
    @RonJohn How so? Withheld amount has no bearing on benefiting from tax credits. – Hart CO Jan 27 '18 at 21:50
  • 1
    What then, is a nonrefundable tax credit? (There must be some difference between them and refundable tax credits. Otherwise, why make a distinction between the two?) – RonJohn Jan 27 '18 at 22:51
  • @RonJohn Of course there's a difference, it's just not relevant here. Even though not relevant, added some explanation of the difference since it's likely a common source of confusion. – Hart CO Jan 27 '18 at 23:02
  • Thanks. That answers my question. I think my confusion arose from the fact that when I do my taxes I can get a "refund", part of which is due to a "non-refundable" credit. – Josh Brown Kramer Jan 28 '18 at 1:38
3

Your eligibility for tax credit has nothing to do with how much you have prepaid or withheld. There are two completely separate ledgers or "tabs" rolling here.

Ledger #1 is your prepayment ledger: the money you have prepaid toward your taxes, in the form of withholding or quarterly payments.

The total of these is the prepayments you have deposited with the government in anticipation of your tax bill.

This is your money, simply on deposit/hold. It's a "tab", but you're the bartender - the government owes you this money unless it's used to pay your taxes.


Ledger #2 is your Taxes Actually Owed register, which is the number that comes out of the bottom of your Form 1040 tax form when you actually fill it out. You can't even compute this ledger until the end of the year.

Tax credits can actually make this number go negative. Your total tax bill becomes a negative number, and even if ledger #1 was $0 because you withheld or prepaid nothing, you still get a refund check. So cool!

However the rules do not allow certain credits to make your tax bill go less than zero. (spoilsports!) These are non-refundable tax credits. Your $1000 refund is one of those.

Non-refundable tax credits have nothing to do with ledger #1. They simply keep ledger #2 from going negative for that credit.


Now. At the end of the year, these two ledgers are pushed together.

Ledger #2 is the tax you owe (or the refundable credit you are owed). Ledger #1 is subtracted from that (i.e. used to pay your taxes). If that number is positive (you still owe more tax) you must pay that by April 15. If the number is negative, (you are owed a refund) they send you one.


Let's try some examples.

Jim has normal, typical taxes. He withholds $100/week for his withholding. His taxes are $7000 but he also gets a $1000 non-refundable tax credit. This goes like this.

      $7000   Tax owed  (part of ledger #2) 
   -  $1000   Non-refundable credits   (part of Ledger #2) 
   ========
       6000   Final total, ledger #2  

   -  $5200   Withholdings and prepayments in ledger #1
   ========
       $800   taxes still owed 

Sue is self-employed and makes quarterly estimated tax payments (into ledger #1). She pays $100 every quarter. When she does her taxes, she owes $700 in tax. She then has a $1000 non-refundable tax credit. Here's what happens.

       $700   Tax owed   (part of ledger #2) 
   -  $1000   Non-refundable credits   (part of ledger #2) 
   ========
          0   Final total   (final total of ledger #2)
   -   $400   Withholdings and prepayments  (final total of ledger #1)
   ========
      -$400   Taxes still owed (in other words, $400 refund)

Same exact facts, but but it's a different credit that is refundable. You can see how this goes different.

       $700   Tax owed   (part of ledger #2) 
    - $1000   Refundable credits   (part of ledger #2) 
    =======
       -300   Final total   (final total of ledger #2)
   -   $400   Withholdings and prepayments  (final total of ledger #1)
   ========
      -$700   Taxes still owed (in other words, $700 refund)

Your case might be more like this.

      $3000   Tax owed   (part of ledger #2) 
    - $1000   Refundable credits   (part of ledger #2) 
    =======
      $2000   Final total   (FINAL total of ledger #2)
   -  $3000   Withholdings and prepayments  (final total of ledger #1)
   ========
     -$1000   Taxes still owed (in other words, $1000 refund)
1

A non-refundable tax credit applies to the total taxes you own for the year. It does not matter how much you already paid, and how much you still have to pay (or to get back). If your total annual tax is lower than the credit, you‘ll miss out on the rest.

A refundable tax credit applies independently of your personal taxes; you will get that money either way, even if your personal taxes are zero. The idea behind that is that you already paid for something (like a new high-efficiency AC), and you get some of that money back.

Tip: If you are really in the situation that you cannot take full advantage of a non-refundable tax credit (which is uncommon), you can consider increasing your taxes for the year (reducing future taxes), and getting more from the credit.
Example: you convert some money from your 401k or IRA into your 401k Roth or IRA Roth (which is a taxable event), and this gets offset by the extra credit you still had. That way, you now have tax-free Roth money instead of to-be-taxed-later non-Roth.
Another option is to do a ‘reverse wash sale’, where you sell a well-going investment, pay taxes on the gains, and immediately buy it back, now having a higher basis; again not really paying those taxes, but using the remaining credit for it.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.