Legal Definitions - tax credit

A tax credit is a direct reduction in the amount of tax a person or organization owes to the government. Unlike a tax deduction, which lowers the amount of income subject to tax, a tax credit is subtracted directly from the final tax bill. This means a $1,000 tax credit reduces your tax liability by exactly $1,000.

Tax credits can be either refundable or non-refundable:

• A non-refundable tax credit can reduce your tax liability to zero, but it will not result in a refund if the credit amount is greater than your tax owed.
• A refundable tax credit, on the other hand, can not only reduce your tax liability to zero but can also result in a payment back to you if the credit amount exceeds the taxes you owe.

Here are some examples illustrating how tax credits work:

• Example 1: Higher Education Credit (Non-Refundable)

  Maria is a recent college graduate who earned $50,000 last year. After all deductions, her calculated tax liability for the year is $2,500. She also qualifies for a $1,000 non-refundable education tax credit because she paid tuition expenses.

  How it illustrates the term: Instead of paying $2,500, Maria subtracts the $1,000 credit directly from her tax bill, meaning she now owes only $1,500. If her tax liability had been only $500, the $1,000 non-refundable credit would have reduced her tax owed to zero, but she would not have received the remaining $500 as a refund.

• Example 2: Electric Vehicle Purchase Credit (Refundable)

  David purchased a new electric vehicle last year and qualifies for a $7,500 refundable tax credit. After calculating his income and deductions, David's total tax liability for the year is $6,000.

  How it illustrates the term: David subtracts the $7,500 credit from his $6,000 tax liability. This not only reduces his tax owed to zero but also means he will receive a $1,500 refund from the government ($7,500 credit - $6,000 liability = $1,500 refund).

• Example 3: Small Business Investment Credit

  GreenBuild Inc., a construction company, invested in energy-efficient equipment for their operations, qualifying for a $10,000 business investment tax credit. Their calculated corporate tax liability for the year is $12,000.

  How it illustrates the term: GreenBuild Inc. applies the $10,000 tax credit directly to their $12,000 tax bill. This reduces their final tax payment to $2,000, directly lowering the cost of their energy-efficient investment and their overall tax burden.