Nonrefundable (solar) tax credit and payroll withholding

[fpbear]

I understand that a nonrefundable tax credit can't exceed the total tax liability for the year, and that excess won't be refunded, but what about tax liabilities already paid via W2 payroll withholding?  Will the payroll tax withholding be refunded in the amount of the nonrefundable tax credit?  This must be a very common scenario but articles don't even talk about this.

For example, I should be able to reduce my payroll tax withholding to end up owing the IRS on the tax return and then use the tax credit to offset what is owed  The logic follows that payroll tax withheld should be refundable - it shouldn't be forfeited just because it was prepaid (same idea as quarterly estimated tax payments for a business).  At least in common sense theory.

Interesting that no one seems to explain this very common scenario.

[Bsch4477]

I think you are misunderstanding what total tax liability is. It is not what you ultimately have to pay, which is affected by your withholding or prepaying tax. Rather it is the tax on your total income. So if you have any tax on your income your credit is applied to that amount and your tax liability is decreased. Only then is your withheld or prepaid tax applied to further reduce what you pay. 

[fpbear]

I found the answer in tax specialist Lane's response here:

https://www.justanswer.com/tax/8weid-solar-does-tax-liability-mean-getting-solar.html

That's good news, looks like I will get a big refund.

The vast majority of articles on this topic are terrible.  They make it sound like a nonrefundable tax credit will never get a refund.  But actually if you prepay more tax than the total tax liability (e.g. through the normal payroll withholding) there can in fact be a refund because of the nonrefundable tax credit.

[NCperson · Accepted solution]

@fpbear - you are correct! 

The confusion begins because most think that the  'withholdings' on the W-2 is the tax you owe and it is not.  The "withholdings" are simply a pre-payment of the tax.  The tax is calculated on your tax return and not on your paycheck!

The concept of 'refundable' and 'non-refundable' isn't explained frequently either.

Here is an example:

Let's assume

1) EV credit of $7500 - this is a 'non-refundable' credit

2) AOTC (college expense credit) of $2500 - this is a 'refundable' credit

3) W-2 withholdings of $3000

4) Tax of $5000 - this is based on the IRS tax tables and appears on Line 16 of Form 1040. See link below on page 3

https://www.irs.gov/pub/irs-dft/f1040--dft.pdf

5) first, the non-refundable credit, such as the EV credit, can be used to reduce Line 16 but it can not take Line 22 below zero.  You can't get a cash refund from these credits (so they are 'non-refundable'),  but you can use them to reduce the taxes you owe, which is another way of stating Line 22 can't go below zero.  In this example, $5000 of the EV credit reduced Line 22 to zero and the remaining $2500 is lost for ever. 

6) Since AOTC is a 'refundable' credit, you CAN get cash from these credits.  So since the AOTC credit is $2500 and the withholdings are $3000, they are added together in the Payments section (sum line 33 of Form 1040) , which is this case is $5500,   As you state, the withholdings are also ' refundable'; they act just like 'refundable credits' and both are in the Payments section of the 1040 - meaning they are used the same way: refundable.

7) The result is a credit of $5500  (line 22 minus Line 33 on Form 1040) , which means you get a refund of $5500. if the result was positive you would still owe.

if you have a Solar credit, that is also non-refundable.  The one difference compared to the EV credit is that if you can't use the entire credit this year (because using only part of the credit brings Line 22 to zero), you can roll over the remaining, unused credit to a future year.  The EV credit doesn't have that flexibility.

does that make sense?