One of the main changes to the Tax Cuts and Jobs Act is certain tax credits that reduce an individual taxpayers’ liability. While most of the tax credits have, roughly, stayed the same, it is important to understand what credits have changed so taxpayers can properly navigate how to take advantage of those changes.
However, before discussing the new changes, it is important to discuss the difference between refundable and non-refundable credits as this aspect of tax credits has not changed and has a direct impact on how the new law may benefit taxpayers.
Refundable v. Non-Refundable Tax Credits
As stated, refundable and non-refundable tax credits are not one of the changes with the act; however, it is still important to understand the difference between the two types of credit. Non-refundable tax credits are credits that offset tax liability but do not themselves create or increase a tax refund (if applicable). Therefore, if there is more non-refundable tax credit amount than the tax amount, the remaining credit is lost. These types of tax credits are applied first to reduce tax liability. Non-refundable tax credits include, for example, lifetime learning credits and retirement savings contribution credit.
Refundable tax credits, meanwhile, work similarly to non-refundable tax credits by reducing a taxpayer’s income tax liability but with the distinction of creating or increasing (if applicable) a taxpayer’s income tax refund. Therefore, if there is more refundable tax credit amount than the tax amount, the remaining credit converts to a refund or adding to a taxpayer’s existing income tax refund depending on the circumstances. These types of tax credits are applied after non-refundable tax credits to reduce tax liability. Refundable tax credits include, for example, earned income credits and additional child tax credit.
Here are two illustrations as to how the non-refundable and refundable tax credits operate.
For example, if a taxpayer has $1,000 in taxes, $500 in non-refundable credits, and $1,000 in refundable credits – the $1,000 in taxes will be reduced by the $500 non-refundable credits. Now, the taxpayer has $500 in taxes remaining. The $1,000 refundable credit will eliminate the remaining 500.00 in taxes, and the taxpayer would be issued a refund of $500.
As a second example, if a taxpayer has $1,000 in taxes and $4,000 in non-refundable tax credits, but no refundable tax credits, then the taxpayer’s taxes would be reduced by the non-refundable credits to $0. The remaining $3,000 in non-refundable tax credits, however, would be lost. The taxpayer would not receive this non-refundable tax credit as a refund or any other benefit.
Main Changes to the New Tax Law
1. Residential Energy Credit- The credit was designed deduct investments by taxpayers to make their homes more energy efficient. This credit was set to expire at the end of 2016. In order for this credit to be extended into 2017, Congress had to extend the credit. However, Congress did not do that, so the credit lapsed. This credit was not necessarily repealed by the new law, it simply was not continued past 2016. As such, a taxpayer will not see this credit when preparing their 2017 income tax return.
2. Child Tax Credit- The credit is for qualifying children of a taxpayer who 14 years of age or younger at the end of the tax filing period in question. The non-refundable credit was originally $1000 per qualifying child. Unlike most non-refundable tax credits, any not used amount would be able to be passed on to the refundable Additional Child tax credit with specific phase-outs depending on income. The new tax law increases the child tax credit to $2,000; however, the refundable portion now has a cap of $1,400 of the $2,000. For example, if a taxpayer used only $500 of the tax credit, he would only be able to use $1,400 of the $1,500 left over. The refundable portion is limited to $1,400 total, no matter the amount of children you are claiming the credit for.
3. Family Credit- This credit was created as a response to the removal of the personal exemption. It encompasses a total $500 per taxpayer, spouse, and each dependent. The credit is non-refundable. However, keep in mind that with both the family credit and the child tax credit, there exist certain phase-out rules.
If you have any questions about any of the credits, feel free to give us a call!