A tax credit reduces the amount of tax for which you are liable. Unlike a deduction, which reduces the amount of income subject to tax, a tax credit directly reduces your tax liability.
A tax credit is usually more valuable than a tax deduction of the same dollar amount. There are two categories of tax credits, refundable and nonrefundable.
Nonrefundable Tax Credits
Most, but not all, tax credits are referred to as nonrefundable credits. A nonrefundable credit can reduce your tax liability to zero (0), but not below. You must have tax liability on line 46 of Form 1040, line 18 of Form 1040A, or line 43 of Form 1040NR to claim a nonrefundable tax credit.
Nonrefundable tax credits include:
- Child and Dependent Care Credit
- Education credits (American Opportunity Credit is also partly refundable)
- Credit for the Elderly or Disabled
- Child Tax Credit
- Foreign Income Tax Credit
- Residential Energy Credits
- Retirement Savings Contribution Credit
Refundable Tax Credits
A refundable tax credit is a tax credit that can reduce your tax liability below zero (0). Because it is possible to receive a refund from this type of credit, they're referred to as refundable.
Refundable tax credits include:
- Earned Income Credit
- Adoption Credit (now refundable for adoptions finalized in 2010 or 2011, or for carryforwards)
- First-time Homebuyer Credit
- Excess Social Security Credit
- Additional Child Tax Credit
- Health Coverage Tax Credit
- American Opportunity Credit - partly refundable