Tax credit
A tax credit is a tax incentive which allows certain taxpayers to subtract the amount of the credit they have accrued from the total they owe the state.[1] It may also be a credit granted in recognition of taxes already paid or a form of state "discount" applied in certain cases. Another way to think of a tax credit is as a rebate.
Refundable vs. non-refundable[edit]
A refundable tax credit is one which, if the credit exceeds the taxes due, the government pays back to the taxpayer the difference.[2] In other words, it makes possible a negative tax liability.[3] For example, if a taxpayer has an initial tax liability of $100 and applies a $300 tax credit, then the taxpayer ends with a liability of –$200 and the government refunds to the taxpayer that $200.
With a non-refundable tax credit, if the credit exceeds the taxes due then the taxpayer pays nothing but does not receive the difference. In this case, the taxpayer from the example would end with a tax liability of $0 (i.e. they could make use of only $100 of the $300 credit) and the government would not refund the taxpayer the $200 difference.
Credit for payments[edit]
Many systems refer to taxes paid indirectly, such as taxes withheld by payers of income, as credits rather than prepayments. In such cases, the tax credit is invariably refundable. The most common forms of such amounts are payroll withholding of income tax or PAYE, withholding of tax at source on payments to nonresidents, and input credits for value added tax.
Value added tax[edit]
Resellers or producers of goods or providers of services (collectively, providers) must collect value added tax (VAT) in some jurisdictions upon billing or being paid by customers. Where these providers use goods or services provided by others, they may have paid VAT to other providers. Most VAT systems allow the amount of such VAT paid or considered paid to be used to offset VAT payments due, generally referred to as an input credit. Some systems allow the excess of input credits over VAT obligations to be refunded after a period of time.
Foreign tax credit[edit]
Income tax systems that impose tax on residents on their worldwide income tend to grant a foreign tax credit for foreign income taxes paid on the same income. The credit often is limited based on the amount of foreign income. The credit may be granted under domestic law and/or tax treaty. The credit is generally granted to individuals and entities, and is generally nonrefundable. See Foreign tax credit for more comprehensive information on this complex subject.
Credits for alternative tax bases[edit]
Several tax systems impose a regular income tax and, where higher, an alternative tax. The U.S. imposes an alternative minimum tax based on an alternative measure of taxable income. Mexico imposes an IETU based on an alternative measure of taxable income. Italy imposes an alternative tax based on assets. In each case, where the alternative tax is higher than the regular tax, a credit is allowed against future regular tax for the excess. The credit is usually limited in a manner that prevents circularity in the calculation.