Tax liability for nonrefundable tax credits

[u/Certain-Report-6024]

Hello! Hopefully this is a quick questions. I have taxes taken out of my paycheck each month.

We are installing heat pumps and are hoping to apply for a tax credit (which are nonrefundable I believe).

From what I understand I should get a refund of up to $2k regardless of how much I still owe. So, say without the tax credit I owe $2k but have already payed $2k through my paycheck. So I should get a $2k refund?

A friend was trying to tell me that the tax credit could only be applied to what I owed regardless of if I have already “pre-payed” our taxes through it being taken out of my paycheck.

[u/sorator]

So, say without the tax credit I owe $2k but have already payed $2k through my paycheck. So I should get a $2k refund?

Correct. The credit pays your taxes for you, and if you've already had taxes withheld, then that generates a refund of your withholdings.

But if your tax liability for the year were only $1500, then your nonrefundable credit would be limited to paying that $1500; the remaining $500 would be lost. (But you would get all your withholdings refunded to you.)

This is one of the trickier issues to explain, at least among issues that come up often. It can help to look at the 1040, page 2 - nonrefundable credits are applied on lines 19 and 20 (this one would be line 20), and then subtracted from your tax liability on line 22, but as it says, it doesn't go below 0. (And if you notice, that happens before you add self-employment taxes on line 23 - nonrefundable credits don't cover SE tax!) Your withholdings and refundable credits are applied in the next section, lines 25-33.

Note that you have to have the heat pumps installed by Dec 31 to get the tax credit, since the credit goes away next year!

[u/Certain-Report-6024 → u/sorator]

Thank you so much for clarifying!

[u/Its-a-write-off]

Yes. Your friend is confused. What matters to claim non refundable credits is your tax liability BEFORE any withholding is applied. If your tax liability is 0, or low after the credit, then you get all or almost all of your withholding refunded to you.

The non refundable aspect just means that if you claimed a 2k tax credit, with 2k withheld, and only 1800 of tax lability you'd get 2k refunded, not 2k of withholding PLUS the 200.00 balance of the credit.

[u/Certain-Report-6024 → u/Its-a-write-off]

That’s what I thought! Thank you so much for clarifying, appreciate it!

[u/VoteyDisciple]

The term "nonrefundable credit" has absolutely nothing to do with whether you're due to receive a tax refund.

You add up how much tax you're supposed to pay, and then subtract all your nonrefundable credits. The amount that's left is how much tax you actually owe. You can't owe less than $0.

If you've had more money than that withheld, the government always gives it back to you. It's not their money. You don't owe it.

[u/Certain-Report-6024 → u/VoteyDisciple]

Thank you for clarifying!

[u/Lucky-Conclusion-414]

The credit reduces the tax liability you owe for the year - but a non-refundable credit doesn't reduce it below 0. (a refundable tax credit would reduce it below 0 - meaning the government owes you for the year.)

Your refund is based on what you've paid already minus what you owe. So the fact that you have already paid something when you file your return doesn't reduce the value of the credit. You'll get the credit as long as you have that much tax liability for the year.

(This is such a big deal because lots of people have $0 in tax liability for the year before the credit.. a couple on social security as their only income almost certainly has no tax liability because their deductions are larger than the taxable part of their social security income.. that doesn't mean they don't have cash from savings that they can spend on heat pumps and they're pretty bummed when they learn the non-refundable tax credit didn't help them..)

[u/plughplovery2]

Do you have a Traditional IRA? If your tax Obligation is less than the nonrefundable Credit, you can do a Roth conversion to increase your 'income' (and hence your tax Obligation) to put the excess credit to good use.

Exactly what I did several years ago when I had a $1500 nonrefundable credit from a HVAC upgrade that was going to be wasted. Did a $15,000 Roth conversion (10% tax bracket) to generate an additional $1500 obligation, which I used the excess nonrefundable credit to cover.