There are two different types of tax credits: refundable and non-refundable. In general, most tax credits aren’t refundable, but there are a few that can add a little extra cash back into your pocket at tax time. There’s a significant difference between the two types, so it’s important to know which category your credit falls into.
Non-refundable credits reduce the amount of taxes owed to the IRS, and can erase your owed taxes entirely in some cases. So, if you have a tax liability of $1,000 and are eligible to claim a non-refundable tax credit worth $2,000, you’ll reduce your taxes to zero, however the IRS keeps any remaining balance. You won’t receive any money back, and aren’t able to carry it forward to another tax year.
Refundable tax credits work a little differently. In the previous scenario, if the tax credit was refundable, your tax debt would still be reduced to zero, though the remaining balance of $1,000 would be refunded to you. These tax credits help to eliminate your tax bill and have an actual refunded amount of the balance on the credit.