Refundable Vs. Nonrefundable Tax Credits

What are tax Credits?

Tax credits reduce your tax liability, which means they directly lower the amount of income tax you owe for the year. If you owe $6,000 in taxes for 2021 but you qualify for $2,000 in tax credits, you will only owe $4,000 in taxes for the year.

Each tax credit has its own eligibility requirements, based on your income, spending, or how many dependents you have. Many tax credits are targeted at families and low-income tax filers.

There are two types of tax credits:

  • Refundable tax credits result in a refund even if you don’t actually owe income tax for the year
  • Nonrefundable tax credits won’t result in a refund if your tax liability is zero

When talking about tax credits, it’s important to distinguish between the refundable portion of a credit, and your overall tax refund. The refund from a tax credit is the amount you get from that credit. Your overall refund — which is the actual payment you get from the IRS after filing your taxes — is the amount by which you overpaid your taxes throughout the year, plus the refunds you got from individual credits.

As an example, let’s say you paid $2,000 of income tax throughout the year but your tax liability was $0. You would get a tax refund of $2,000. If you also qualify for a refundable credit worth $500, then your overall tax refund will be $2,500.

Tax Credits vs. Tax Deductions

Credits and deductions both decrease your income tax bill, but they do so in different ways. A tax deduction reduces your taxable income. If you made $75,000 and take $15,000 of deductions, only $60,000 of your income is used to calculate how much tax you owe. This will result in owing less tax, but the effect is indirect. Tax credits directly decrease how much tax you owe, so they are generally seen as more valuable than deductions. That’s one reason credits are often available to lower-income tax filers and those who cannot otherwise afford certain types of payments. However, many tax filers will qualify to take some credits and some deductions on their tax return.

Refundable tax credits

A refundable tax credit will pay you a refund if the amount of credit you qualify for is greater than the amount of income tax you actually owed for the year. More technically, refundable credits pay a refund if they bring your tax liability below zero.

Not all refundable credits are fully refundable, so you may only qualify to get a refund up to a certain value. As an example, let’s say your tax liability was $1,000 and you qualified for a tax credit worth $1,500. If the credit is fully refundable, you will get a $500 refund (the credit pays off the first $1,000 in tax liability and you get the rest). However, let’s say the credit is only partially refundable, up to $300. You will get a refund of $300, even though it means you aren’t getting the full value of the credit you qualified for.

Here are five refundable tax credits you may qualify for:

  • Earned income tax credit (EITC)
  • Premium tax credit (PTC)
  • American opportunity tax credit (AOTC)
  • Life Time Learning Credit
  • Additional child tax credit (ACTC)
  • Health coverage tax credit (HCTC)
  • Earned income tax credit (EITC)

The EITC primarily benefits low-income taxpayers, but the income requirements and credit amounts depend on how many children you have. For 2021 taxes, the EITC is worth up to $543 for people with no children and up to $6,728 for people with three or more children. The EITC is fully refundable and individuals who wouldn’t normally have to file a tax return may still want to file a return just to claim the EITC.

  • Premium tax credit (PTC)

If you get a health insurance plan through the Obamacare marketplace and your household income is between 100% and 400% of the federal poverty line, the PTC will reimburse the amount you spent on monthly premiums. The PTC is fully refundable. You can also receive it in advance — each month instead of just when you file your return — by taking the advance premium tax credit (APTC).

  • American opportunity tax credit (AOTC)

The AOTC is available for taxpayers with certain education expenses — tuition, books and classroom supplies. The credit is worth up to $2,500 per student and if it brings your liability below $0, you can get a refund for 40% of the remaining credit amount, with a maximum refund of $1,000. See if you qualify for the AOTC.

  • Life Time Learning Credit

You can claim 20% of the first $10,000 you paid toward tuition and fees, for a maximum of $2,000. Like the American opportunity tax credit, the lifetime learning credit doesn’t count living expenses or transportation as eligible expenses. You can claim books or supplies needed for coursework.

  • Additional child tax credit (ACTC)

If you took the child tax credit (nonrefundable) and your credit amount was greater than your tax liability, you can claim the ACTC in order to get a refund. The ACTC can result in a refund worth up to $1,400 per child.

  • Health coverage tax credit (HCTC)

The HCTC covers 72.5% of your health insurance premiums, including COBRA coverage, if you meet either of these criteria:

  • You’re between the ages of 55 and 64, and you have a pension that was taken over by the Pension Benefit Guaranty Corporation (PBGC).
  • You receive benefits through Trade Adjustment Assistance (TAA), Alternative Trade Adjustment Assistance (ATAA), or Reemployment Trade Adjustment Assistance (RTAA). You may qualify for these programs if you lost your job due to changes in international trade, but you will need to petition the Department of Labor so it can certify you as eligible.

Nonrefundable tax credits

A nonrefundable tax credit can only be worth as much as your tax liability. For example, if you owed $1,200 of tax for the year and qualified for a nonrefundable tax credit worth $1,600, only $1,200 of the credit would apply to your tax return.

Most federal tax credits are nonrefundable, but some of them do allow you to carry over any unused credit onto next year’s tax return.

Here are 10 common nonrefundable credits:

  • Child tax credit (CTC)
  • Credit for other dependents (ODC)
  • Adoption credit
  • Lifetime learning credit (LLC)
  • Saver’s credit
  • Child and dependent care tax credit
  • Foreign tax credit
  • Credit for the elderly or the disabled
  • Energy tax credits
  • Credit for electric plug-in vehicles
  • Child tax credit (CTC)

Most parents qualify for the child tax credit. It’s worth up to $2,000 per eligible child you have, and you can qualify if your income is less than $400,000 if you’re married filing jointly or $200,000 for all other filing statuses. (You must have earned income of at least $2,500 to qualify.) The CTC is not refundable but if you would have qualified for a refund, you can claim the additional child tax credit, which is refundable.

  • Credit for other dependents (ODC)

The ODC is available if you have dependents who wouldn’t qualify for the CTC, such as a parent or sibling you care for. It’s worth up to $500 per dependent and you can claim it using the same tax forms as the CTC.

  • Adoption credit

The adoption credit is worth up to $14,080 per child, based on the adoption costs you incurred. It’s not refundable but any amount you can’t claim on this year’s return can be carried over for up to five years.

  • Lifetime learning credit (LLC)

The LLC is worth up to $2,000 per tax return for educational expenses. Eligible expenses can include undergraduate courses, graduate courses, professional degree courses, and classes you take for learning or improving job skills. See who should claim the lifetime learning credit.

  • Retirement savings contributions credit (saver’s credit)

The saver’s credit is worth up to 50% of your contributions to an IRA, employer-sponsored retirement plan, or ABLE account. The maximum credit is $4,000 for joint tax filers and $2,000 for all others. To claim at least some of the saver’s credit in 2021, your income must be $66,000 or less if you’re a joint filer and $33,500 or less if you’re a single filer. For the full credit, your income must be $39,500 or less if you’re a joint filer and $19,750 or less if you’re a single filer.

  • Child and dependent care tax credit

If you had to pay for childcare (or for someone to care for a nonchild dependent) so you could work or look for work, the dependent care credit can reimburse your expenses. The maximum credit is $3,000 if you had one dependent and $6,000 if you had more than one dependent.

  • Foreign tax credit

The foreign tax credit reimburses you if you already paid tax on income from another country. In addition to income from working in another country or territory, you may qualify for the foreign tax credit if you paid taxes on interest and investment income from a foreign source. Check your 1099-DIV, 1099-INT, and Schedule K-1s to see if you have foreign income. (Learn about what’s on your 1099 forms.)

  • Credit for the elderly or the disabled

The credit is available to individuals who are at least 65 years old or who are under 65 and receive disability benefits. The income limit depends on your filing status, but it ranges from $12,500 to $25,000.

  • Energy tax credits

There are two main renewable energy tax credits an individual may qualify for. If you installed certain types of renewable energy in your home, you may be able to get a credit worth up to 10% of the cost by claiming the residential renewable energy tax credit. General improvements you make to your home in order to increase its overall energy efficiency may qualify you for the nonbusiness energy property credit.

  • Credit for electric plug-in vehicles

Taxpayers with a plug-in electric vehicle may qualify for a tax credit worth up to $7,500. A vehicle may qualify whether it was for personal or business use.

In-Home Support Services (IHSS) Income (Non-Taxable)

In-Home Support Services (IHSS) income is given to taxpayers who are providing care to individuals who would otherwise require care in a hospital, nursing facility, or intermediate care facility. The taxpayer providing the care is caring for this individual in their home.

This income is typically reported on a W2, under the state of California the EIN is 20-0548930. It will have the name of the person receiving the care in the area of the Employer’s Name.

Per IRS Notice 2014-7, issued in 2014, this income is no longer taxable. The W2 may or may not have income under Box 1 of the W2.

  • If the income under Box 1 is “0” then no action needs to be taken.
  • If the income is being reported, the tax preparer needs to zero out that income to ensure it is not taxable by taking the following steps
  1. Enter the W2 as it is presented on the tax document
  2. Go to the “Other Income” area on the 1040
  3. Enter “IHSS INCOME – NON TAXABLE – NOTICE 2014-7” as the description of the “Other Income”
  4. Put the amount reported in Box 1 of the W2 adjacent to this description as a negative figure
  5. The 1040 should now show the income reduced to zero.

IRS Resource:

https://www.irs.gov/individuals/certain-medicaid-waiver-payments-may-be-excludable-from-income

Home Office Expense (Sole Proprietorship) (Form 8829)

If you use part of your home for business, you may be able to deduct expenses for the business use of your home. The home office deduction is available for homeowners and renters, and applies to all types of homes. 

There are two methods to claim this expense on your Individual Tax Return

Simplified Option

This new simplified option can significantly reduce the burden of recordkeeping by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in lieu of determining actual expenses.

The standard method has some calculation, allocation, and substantiation requirements that are complex and burdensome for small business owners.

This is not the method our firm uses, as it usually has less of a benefit to the taxpayer.

Regular Method

Taxpayers using the regular method, must determine the actual expenses of their home office. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation.

Generally, when using the regular method, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities.

Requirements to Claim the Home Office Deduction

Regardless of the method chosen, there are two basic requirements for your home to qualify as a deduction:

  1. Regular and exclusive use.
  2. Principal place of your business.

Regular and Exclusive Use

You must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.

 

Principal Place of Your Business

You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction.

For example, if you have in-person meetings with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business.

You can deduct expenses for a separate free-standing structure, such as a studio, garage, or barn, if you use it exclusively and regularly for your business. The structure does not have to be your principal place of business or the only place where you meet patients, clients, or customers.

Generally, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities.

If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home.

Mortgage Interest, Real Estate Taxes & Mortgage Insurance will not be accounted for twice. Instead, the remaining amount of unused expense that isn’t used for the home office expense will apply to Schedule A (Itemized Deductions).

Regular Method Required Information

Area used regularly & exclusively for business(Square Footage)
Total Area of Home(Square Footage)
Total Wages from this business$
Percent of Wages from the business use of this home$
Deductible Mortgage Interest (Form 1098)$
Real Estate Taxes$
Insurance$
Rent$
Repairs & Maintenance$
Utilities$
Other Expenses$
Other Expenses$
Other Expenses$
Other Expenses$
Other Expenses$

Home Office Expense (Individuals who don’t have Businesses)

While you may be using your home as a home office, if you have are a W2 employee this expense will not benefit you, per the current tax law. The home office expense used to be claimable under Schedule A (Itemized Deductions) > Form 2106 (Unreimbursed Employee Expenses) > Employee Home Office. However after the Tax Cuts & Jobs Act, the expense is now disallowed on the Federal return. It may have little to no impact on the State Return.

Home Office Expense (S-Corp, Partnership, C-Corp)

If you are an employee of your own one-man corporation, whether a regular “C” corporation or a “sub-chapter S” corporation, you have several choices for handling the costs of a qualifying home office:

  1. The S corporation can pay you rent for the home office. (If this option is chosen, the income is taxable under your Individual Tax Return’s Schedule E)
  2. The S corporation can pay you for the costs of a home office under an “accountable” plan for employee business expense reimbursement.

Accountable plan for S-corporation deductions and reimbursements

The second option, being reimbursed under an accountable plan, provides the greatest tax savings. It is an excellent way to get money out of your closely-held corporation tax-free. The corporation can deduct the amount of the reimbursement and you do not have to report the payment on your personal income taxes.

This option is “more better” than having the corporation pay you rent for the home office. While your corporation can deduct the rent paid to you, you must report the rent as income on Schedule E.

To qualify as a home office, the space (it does not have to be an entire room) must be used regularly (on a continuous, ongoing or recurring basis) and exclusively (there can be no personal use) for your trade or business, and it must be your principal place of business or a place where you physically meet with patients, clients or customers on a regular basis. The space will be considered your principal place of business if it is used for performing administrative or management activities, such as billing, bookkeeping, ordering supplies, setting up appointments and writing reports, and there is no other fixed location where you regularly perform these activities.

As an employee the home office must be for the convenience of your employer. This means the home office is required as a condition of employment, it is necessary for the business to function or it is necessary for you to properly perform your duties as an employee. If you do not have any other place of business, such as a rented office or storefront, your home office should qualify.

Example:

I used to rent an office for my tax practice. Even though I did administrative work in a “regular and exclusive” space at home, and on rare occasions met with clients there, I could not claim a home office deduction or be reimbursed for home office expenses. I have since given up the rented office and work exclusively out of my home. I now have a home office that qualified for a home office deduction.

For an expense reimbursement plan to be considered “accountable,” the expenses that are reimbursed must be for actual job-related expenses (you cannot reimburse personal expenses) and you, as the employee, must substantiate the expenses by providing your employer with receipts or other documentation. Under TCJA, this is only available for independent contractors and not employees.

You should create a monthly “Employee Expense Report” form for your corporation. This is a good idea whether or not you have a home office. Start out with lines for business mileage and other out-of-pocket business expenses, such as postage, office supplies, parking and tolls, meals and entertainment, etc. Staple receipts for these items to the report.

Include a Home Office section in the report. Calculate the “business use percentage” of your home office by dividing the square footage of the office area by the total square footage of the home. List each item of expense paid during the month, such as:

  • real estate taxes
  • homeowner’s insurance
  • oil heat, gas and electric
  • water and sewer
  • alarm or security service
  • garbage disposal
  • general repairs and maintenance
  • mortgage interest (taken from the monthly mortgage billing statement or a loan amortization statement you can create online)

Multiply the total of these expenses by the business use percentage to determine the amount to be reimbursed. Total up all the business expenses listed on the form, including the home office amount, and write a check from the corporation to yourself for this amount. To be clear, this only applies if you claim the home office deduction if you have your own business and use a portion of your home for your business. It is no longer allowed for employees under TCJA.

You must reduce the amount of your itemized deduction for real estate taxes and mortgage interest by the amount of reimbursement you receive from your corporation during the year for these items. If your real estate taxes for the year are $10,000, but in the course of the year you were reimbursed $2,000 by the corporation, you can only deduct $8,000 in real estate taxes on Schedule A.

See the next page for a template for the Monthly “Employee Expense Report” form. This has to be provided to the tax accountant for preparation of your corporation return.

Download this file here:

Foreign Reporting Quick Guide

Foreign Reporting Quick Guide

Our firm supports many international clients as well as clients with international activity. The guide below outlines the different form types and purposes behind each.

NameFiling FormDescriptionDeadline
Foreign Bank and Financial Accounts (FBAR)114A United States person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.   This can be filed with the individual tax return through Proseries for a separate fee.Same as Individual Tax Deadline
Foreign Account Tax Compliance Act (FATCA)8938You have to file Form 8938 if a specified foreign financial asset you own directly has a total aggregate value of $50,000.Same as Individual Tax Deadline
Double Taxation Credit1116The United States is a party to tax treaties designed to prevent double taxation of the same income by the United States and the treaty country. Certain treaties allow a U.S. citizen an additional credit for part of the tax imposed by the treaty partner on U.S. source income. This is the foreign income credit, unused portions carryforward.Same as Individual Tax Deadline
Foreign Earned Income Exclusion2555If you’re an American working and living overseas this form lets you claim the Foreign Earned Income Exclusion, which (if you qualify for it) can reduce the income by the exclusion. $105,900 for 2019$107,600 for 2020 $108,700 for 2021 $112,000 for 2022Same as Individual Tax Deadline
Information Return of U.S. Persons With Respect To Certain Foreign Corporations  5471  Certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations file Form 5471 and schedules to satisfy the reporting requirements of sections 6038 and 6046, and the related regulations.June 15th
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