Tax credits come in two varieties: refundable and non-refundable. The majority of tax credits fall under the latter, though there are some that can put more of your hard-earned money back into your bank account. At tax time, you need to know if the credit you are claiming is refundable or not, so you know exactly what to expect when you calculate your refund.
Like all tax credits, non-refundable ones still serve their purpose of reducing the amount of taxes due to the IRS. In some situations, tax credits can completely eliminate your tax debt. How non-refundable credits work:
You owe the IRS $1,500 in taxes but qualify to claim a $2,000 non-refundable tax credit. Your tax debt is reduced to zero, and the remaining $500 from the credit is eliminated. You won’t receive any money back, and the balance is non-transferable and can’t be carried over to another tax year.
Refundable tax credits are slightly different. If the tax credit in the previous situation was refundable, the $500 balance (after your tax debt was eliminated) would be awarded to you in a refund. These types of credits are two-fold: they can eliminate your tax debt fully and return some much-needed cash back to your hands!