8563 / How does a nonrefundable tax credit work and what are some examples?

A nonrefundable credit is a credit that is limited by the amount of the taxpayer’s tax liability for the year. A taxpayer is only entitled to claim nonrefundable tax credits to the extent that the combined amount of the credits does not exceed total income tax liability for the tax year. So, unlike refundable credits ( Q 8553), a nonrefundable credit can never result in a refund or credit.

However, because certain nonrefundable credits in excess of a taxpayer’s tax liability for a tax year may be carried forward into future tax years (and others cannot be carried over), it is important to consider the order in which a taxpayer claims the nonrefundable credits.¹

The following tax credits are classified as nonrefundable credits:

…Personal credits which consist of the child and dependent care credit;² the credit for the elderly and the permanently and totally disabled,³ the qualified adoption credit,⁴ the nonrefundable portion of the child tax credit,⁵ the American Opportunity (the increased limits were made permanent by PATH), Hope Scholarship, and Lifetime Learning credits,⁶ the credit for elective deferrals and IRA contributions (the “saver’s credit,” which became permanent under PPA 2006);⁷

…The nonbusiness energy property credit (renamed the Energy Efficient Home Improvement Credit and extended through 2032)⁸; and the residential energy efficient property credit (renamed the Residential Clean Energy Credit and extended through 2034);⁹

…Other nonbusiness credits;¹⁰

…The general business credit is the sum of the following credits determined for the taxable year:

(1)  the investment credit determined under IRC Section 46 (including the rehabilitation credit);

(2)  the work opportunity credit determined under IRC Section 51(a) (extended through 2025);

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Planning Point: The work opportunity tax credit can provide a valuable tax benefit for business owners who hire certain workers through the end of 2025. Businesses can claim the WOTC for hiring workers classified into one of ten groups. One of those groups includes individuals who have been unemployed for at least 27 consecutive weeks and have received state or federal unemployment benefits for at least a portion of that period. Employers are required to satisfy a pre-screening requirement to claim the credit. The pre-screening requirement is satisfied when the employer and the job applicant complete Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, on or before the day a job offer is made.¹¹ The employer also must submit Form 8850 to their state workforce agency (not to the IRS) within 28 days after the employee begins work. The employer claims the credit on their federal income tax return, based on wages paid during the first year of employment. The credit is calculated on Form 5884 and claimed on Form 3800, General Business Credit. Because of the pandemic and widespread unemployment relief, many additional small business clients may qualify for this credit in 2021 and 2022.

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(3)   the alcohol fuels credit determined under IRC Section 40(a);

(4)   the research credit determined under IRC Section 41(a) (made permanent by PATH);

(5)   the low-income housing credit determined under IRC Section 42(a);

(6)   the enhanced oil recovery credit under IRC Section 43(a);

(7)   in the case of an eligible small business, the disabled access credit determined under IRC Section 44(a);

(8)   the renewable electricity production credit under IRC Section 45(a) (extended only through 2009 under EIEA 2008);

(9)   the empowerment zone employment credit determined under IRC Section 1396(a) (extended through 2025);

(10)  the Indian employment credit as determined under IRC Section 45A(a) (extended through 2021);

(11)  the employer Social Security credit determined under IRC Section 45B(a);

(12)  the orphan drug credit determined under IRC Section 45C(a);

(13)  the new markets tax credit determined under IRC Section 45D(a) (extended through 2025);

(14)  in the case of an eligible employer (as defined in IRC Section 45E(c)); the small employer pension plan startup cost credit determined under IRC Section 45E(a);

(15)  the employer-provided child care credit determined under IRC Section 45F(a);

(16)  the railroad track maintenance credit determined under IRC Section 45G(a) (made permanent by the 2021 CAA, although the credit was reduced from 50 percent to 40 percent);

(17)  the biodiesel fuels credit determined under IRC Section 40A(a) (extended through 2024 under the Inflation Reduction Act of 2022);

(18)  the low sulfur diesel fuel production credit determined under IRC Section 45H(a);

(19)  the marginal oil and gas well production credit determined under IRC Section 45I(a);

(20)  for tax years beginning after September 20, 2005, the distilled spirits credit determined under IRC Section 5011(a);

(21)  for tax year beginning after August 8, 2005, the advanced nuclear power facility production credit determined under IRC Section 45J(a);

(22)  for property placed in service after December 31, 2005, the nonconventional source production credit determined under IRC Section 45K(a);

(23)  the energy efficient home credit determined under IRC Section 45L(a) (extended through 2032);

(24)  the energy efficient appliance credit determined under IRC Section 45M(a) (extended through 2014);

(25)  the portion of the alternative motor vehicle credit to which IRC Section 30B(g)(1) applies;

(26)  the portion of the alternative fuel vehicle refueling property credit to which IRC Section 30C(d)(1) applies (extended through 2032);¹²

(27)  for eligible employers, the paid family and medical leave credit determined under IRC Section 45S (created by the 2017 tax reform legislation and extended through 2025).

A credit was also available for new qualified plug-in electric drive motor vehicles acquired and placed in service after 2009. The amount of the credit can vary from $2,500 to $7,500 depending on battery capacity (and subject to phase-out based on number of vehicles sold by the manufacturer). The portion of the credit attributable to property of a character subject to an allowance for depreciation is treated as part of the general business credit. The balance of the credit is generally treated as a nonrefundable personal credit.¹³ An alternative credit is available for certain plug-in electric cars placed in service after February 17, 2009 and before 2022. This credit is equal to 10 percent of cost, up to $2,500.¹⁴ This tax credit has been extended through 2032 and expanded by the Inflation Reduction Act (see Q 767 for details).