What Is The Difference Between A Refundable and Non-Refundable Tax Credit?

The key difference between a refundable and non-refundable tax credit is that a refundable credit allows the taxpayer to receive the full value of the credit even if it exceeds their income tax liability, while a non-refundable credit cannot exceed taxes owed.

With a refundable tax credit like the employee retention tax credit (ERTC), if the credit amount is more than a company’s tax liability, the IRS will refund the excess. So the full credit value is realized.

For a non-refundable credit, it is limited to the tax liability. For example, if a $10,000 non-refundable credit is earned but taxes owed are only $4,000, the credit value is reduced to $4,000.

The ERTC was made fully refundable to maximize its benefit for employers. Companies received refunds if their ERTC exceeded payroll taxes owed.

In contrast, credits like the research tax credit are non-refundable. Its value cannot extend beyond income tax liabilities to generate a net refund payment.

The key takeaway is that refundable credits provide the full dollar benefit, while non-refundable credits are capped at income taxes owed.

Is The Employee Retention Tax Credit Refundable (ERTC)?

Yes, the employee retention tax credit (ERTC) was structured as a fully refundable tax credit when it was implemented under the CARES Act.

This refundable design meant that if an employer qualified for the credit, they could benefit from the full value even if it exceeded their federal employment tax liability for a quarter.

Specifically, eligible employers could use their ERTC to offset their share of Social Security taxes owed on employee wages for a quarter. If the ERTC exceeded that liability, the IRS refunded the remainder to the employer.

For example, if an employer qualified for a $10,000 ERTC but only owed $3,000 in federal payroll taxes for the quarter, they could wipe out their $3,000 liability completely and receive the remaining $7,000 as a refund.

The ERTC being fully refundable enabled employers to realize the maximum benefit to aid in retaining employees during COVID-19 challenges. This was crucial for struggling businesses without taxable income.

In summary, the refundable structure provided flexible and meaningful relief through the ERTC regardless of an employer’s tax situation.

How Does a Refundable Tax Credit Benefit Companies Compared To a Non-Refundable Credit?

A key advantage of a refundable tax credit compared to a non-refundable credit is that the full value of a refundable credit can be realized by companies even if it exceeds their federal income tax liability.

With the employee retention tax credit (ERTC) being refundable, eligible employers could obtain the maximum credit benefit through refunds if their ERTC exceeded payroll taxes owed for a quarter.

For non-refundable credits, companies can only utilize the credit up to the amount of income tax they owe. So the full value is not accessible if it surpasses tax liabilities.

Examples of how refundable credits like the ERTC provide enhanced benefits:

  • Startup companies with little or no income taxes owed can benefit
  • Struggling businesses see immediate cash flow help through refunds
  • Tax-exempt employers like non-profits can now utilize the credits
  • Carryforward limits on non-refundable credits are avoided

Overall, the refundable structure provides more flexible and meaningful relief. Companies receive the full dollar amount they qualify for instead of leaving unused credits on the table due to tax limitations.

Can Companies Get a Tax Refund From The ERTC Even If They Had No Tax Liability?:

Yes, the refundable nature of the employee retention tax credit (ERTC) allowed many more types of employers to benefit compared to if it had been designed as a non-refundable credit.

Because the ERTC exceeded payroll tax liabilities, companies could receive substantial refunds. This enabled struggling or tax-exempt employers to take advantage of the relief.

Types of companies that benefited more from the refundable credit:

  • Startups and unprofitable businesses with little or no tax liability
  • Companies facing COVID challenges with significantly reduced income
  • Non-profit organizations like churches and charities
  • Small businesses more heavily impacted by pandemic disruptions
  • Companies with tax losses eliminating income tax obligations

If the ERTC had been non-refundable, these types of employers would have seen the value reduced or eliminated due to low tax liability.

By making the credit refundable, Congress enabled it to achieve its goal of providing relief to all businesses affected by the pandemic. More employers could retain staff even with economic uncertainty.

What Are Some Other Key Refundable Tax Credits Companies Can Claim Besides The ERTC?

In addition to the employee retention tax credit (ERTC), some other valuable refundable tax credit programs available to businesses include:

  • Research tax credit – Can provide a credit of up to 20% of qualified research expenses.
  • Work opportunity tax credit – Offers benefits for hiring certain targeted groups facing disadvantages.
  • Small business health care tax credit – Helps offset the cost of providing health insurance.
  • Low-income housing tax credit – Incentivizes affordable housing investments and construction.
  • New markets tax credit – Spurs investments in low-income communities.
  • Renewable electricity production tax credit – Supports renewable energy like wind and solar.
  • Carbon capture tax credit – Promotes greenhouse gas emission-reducing technology.

A key benefit these refundable credits offer is allowing companies to obtain the full value even if it exceeds tax liability. This flexible structure helps more businesses utilize the incentives.

The ERTC provided meaningful relief in retaining employees, while these ongoing options encourage investments and activities benefitting economic growth and society.

What Are Examples Of Major Non-Refundable Tax Credits For Businesses?

Some major non-refundable income tax credits commonly used by businesses include:

  • Research and development tax credit – Provides a credit of up to 20% for qualified research expenses.
  • Foreign tax credit – Offsets federal liability based on taxes paid to foreign countries.
  • Rehabilitation tax credit – Historic preservation incentive of up to 20% for rehab costs.
  • Low-income housing tax credit – Credit based on investments in affordable housing projects.
  • New markets tax credit – Credit for investments in low-income community projects.
  • Disabled access credit – Credit for making accessibility improvements for the disabled.
  • Employee child care tax credit – Credit up to 25% of expenses for employee child care.
  • Biodiesel fuel credit – Credit for selling or using biodiesel fuel blends.

A key limitation of these non-refundable credits is that they cannot reduce tax liability below zero to generate a net refund. Only the refundable portion of some credits provides that benefit.

Businesses should optimize the use of these non-refundable credits each year but be aware the value may be capped based on tax liabilities.

How Do Limitations On Carrying Forward Non-Refundable Credits Minimize Their Value?

The inability to carry forward unused non-refundable tax credits indefinitely is one key limitation that minimizes the ultimate value and benefits companies receive.

For credits like the research tax credit or disabled access credit, if companies cannot use the entire credit in the tax year earned, there are restrictions on carryforwards:

  • R&D credit – This can only be carried forward up to 20 years.
  • Disabled access credit – This can only be carried forward up to 15 years.
  • Foreign tax credit – Can only be carried forward up to 10 years.
  • Rehabilitation credit – 20-year carryforward period.
  • Employee child care credit – Only a 5-year carryforward.

These limitations create a “use it or lose it” pressure around non-refundable credits. The clock starts ticking once earned.

Whereas with refundable tax credits like the employee retention credit, companies obtain the full current cash benefit. There is no need to worry about losing unclaimed portions years later.

The refundable credit structure provides more flexibility and certainty of utilizing the full value within the window the incentive applies rather than based on the company’s future tax situation.

Can Tax-Exempt Organizations Benefit From The Refundable ERTC?

Yes, tax-exempt organizations were able to benefit from the employee retention tax credit (ERTC) specifically because it was designed as a refundable tax credit.

As non-profit entities, tax-exempt companies do not face the same federal income tax obligations. So non-refundable credits would be worthless or extremely limited in value.

But with the ERTC being refundable, tax-exempt employers could claim the credit based on qualified wages paid in 2020 and 2021 and receive the full allowable amounts as refunds from the IRS.

For example, a hospital with 1,000 employees facing COVID-19 challenges could potentially qualify for up to $7 million in ERTC ($7,000 per employee). Even as a non-profit with no income tax bill, they could obtain the full $7 million as a refund.

Whereas non-refundable credits would provide little or no benefit to a tax-exempt organization. The refundable structure opened up ERTC relief to crucial employers like healthcare, education, and charitable organizations during the pandemic.

The IRS recognized refundable credits like ERTC provide vital assistance to tax-exempt organizations facing economic hardship.

Where Can I Find More Information Comparing Refundable and Non-Refundable Tax Credits?

To learn more about refundable versus non-refundable tax credits for businesses, some useful resources include:

  • IRS Form 3800 instructions – Outline key differences between refundable and non-refundable credits.
  • IRS Publication 542 – Covers corporation tax credits including refundability.
  • Journal of Accountancy article – Provides definitions and examples of each type of credit.
  • AccountingTools review – Explains key traits and limitations of non-refundable credits.
  • Investopedia article – Discusses major refundable credits available for individuals and businesses.
  • EY guide – Provides charts summarizing major refundable and non-refundable credits.
  • Wolters Kluwer CCH review – Looks at the most common refundable credits such as EITC and CTC.
  • Credit for Small Employers guide – Details a new refundable credit for small businesses providing health care.
  • BKD article – Advises on steps to maximize refundable credit benefits.

The key takeaway is that only refundable credits like the ERTC allow companies to benefit from the full value by receiving refunds in excess of tax liability. Non-refundable credits are capped at income taxes owed.

Here Are Two Additional Resources Comparing Refundable and Non-Refundable Tax Credits:

https://www.irs.gov/pub/irs-pdf/p4990.pdf

An IRS publication defining and contrasting the two types of credits.

https://bench.co/blog/accounting/refundable-vs-nonrefundable-tax-credits/

A Bench article with examples highlighting the key differences between refundable and nonrefundable credits.

Step 12: Here are two additional resources comparing refundable and non-refundable tax credits:

https://www.irs.gov/pub/irs-pdf/p4990.pdf

An IRS publication defining and contrasting the two types of credits.

https://bench.co/blog/accounting/refundable-vs-nonrefundable-tax-credits/

A Bench article with examples highlighting the key differences between refundable and nonrefundable credits.

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