Types of Tax Credits: The Three Ways the IRS Lets You Cut Your Tax Bill

Financial Horizons: Insights for Building Wealth and Securing Your Legacy

By Dr. Jose G. Cardenas, Chief Tax Strategist at The C & R Group, LLC

Here’s the deal—tax credits are the closest thing to “cheat codes” in the tax code.

Most people obsess over deductions, but deductions only lower the income you’re taxed on. Tax credits do something much more powerful:

A tax credit reduces your tax bill dollar-for-dollar.

But not all credits are created equal. Some can only take your tax down to zero. Others can actually put cash back in your pocket. And a third group lives in the middle.

In this article, we’ll break down the three main types of tax credits:

1. Nonrefundable tax credits
2. Refundable tax credits
3. Partially refundable tax credits

Once you understand the difference, you’ll see why credits are a key lever in any serious tax strategy.

Quick Reminder: Credit vs. Deduction

Before we get into types, let’s get crystal clear on the basics.

• A deduction reduces the income you’re taxed on.
  Example: If you earn $60,000 and have $10,000 in deductions, you’re taxed on $50,000.
• A credit reduces the tax itself.
  Example: If your tax bill is $3,000 and you have a $1,000 credit, it can drop to $2,000 (or even lower depending on the type of credit).

Deductions soften the blow.
Credits punch the tax bill in the face.

Now let’s look at the three flavors.

1. Nonrefundable Tax Credits: They Can Take You to Zero—But Not Below

A nonrefundable tax credit can reduce your tax bill down to $0, but never below $0.

If you don’t owe enough tax to use the full credit, the unused portion is usually lost (unless the law for that specific credit allows carryforwards).

Example in plain English:

• Your tax bill: $1,200
• Nonrefundable tax credit: $1,500

The IRS will let that credit wipe out the $1,200 you owe, but they won’t send you the extra $300. Your tax goes to zero and stops there.

Nonrefundable credits are powerful, but they reward you most when you already have some tax liability to offset.

For many households, nonrefundable credits show up around:

• Certain education-related credits
• Some energy-efficient home improvement credits
• Various “incentive” credits tied to specific behaviors or investments

The key idea: if it’s nonrefundable, it’s a shield, not a cash faucet.

2. Refundable Tax Credits: These Can Put Cash Back in Your Pocket

Refundable credits are where people’s eyes light up—and for good reason.

A refundable tax credit can do two things:

1. Reduce your tax bill down to zero, and then
2. If there’s still credit left, the extra amount can be paid to you as a refund.

Example:

• Your tax bill: $800
• Refundable tax credit: $1,500

The credit wipes out the $800 you owe and the remaining $700 can come back to you as part of your refund (subject to the specific rules and limits of that credit).

Refundable credits are especially important for:

• Lower- and moderate-income working families
• People with children
• Certain situations where the government is trying to support work, education, or other key priorities

From a planning standpoint, refundable credits can be a major cash-flow tool. But you still need to qualify—and that’s where strategic planning around income level, filing status, and family structure matters.

3. Partially Refundable Tax Credits: The Hybrid Model

Partially refundable credits sit in the middle: part of the credit acts like a nonrefundable shield, and part of it acts like a refundable faucet.

In other words:

They can reduce your tax bill to zero and may give you some additional cash back—but only up to a certain amount or percentage.

Example:

• Total credit: $2,500
• Rules say: up to $1,000 of this credit is refundable if conditions are met.

If your tax is $1,800:

• $1,500 of the credit may wipe out your tax
• Up to $1,000 may come back as a refundable portion (subject to rules, income thresholds, and formulas)

Many family- and education-related credits have been structured this way at various points in time, with specific rules about:

• Income thresholds
• Earned income requirements
• Maximum refundable amounts

This is why you can’t just read the name of a credit and assume how it works—you need to know what type of credit it is and what the under-the-hood rules are.

Why Knowing the Type of Credit Actually Matters

Most people just see a credit and think, “Cool, free money.” But from a strategy standpoint, knowing whether a credit is nonrefundable, refundable, or partially refundable makes a huge difference.

1. It Changes How You Plan Your Income

Some credits phase out as your income climbs. Others require a minimum amount of earned income to unlock the refundable portion.

This affects decisions like:

• Taking extra overtime vs. staying under certain thresholds
• When to realize capital gains
• How much business income to recognize this year vs. next

If you’re playing at a higher level with your income, you want to know exactly where these cliffs and sweet spots are.

2. It Impacts Withholding and Estimated Tax Payments

If you qualify for significant refundable credits, your expected refund might be larger than you think—meaning you could potentially adjust withholding or estimated payments (carefully, with a plan) to improve cash flow during the year.

On the other hand, if your credits are mostly nonrefundable, you need to make sure you’re not counting on refunds that won’t materialize.

3. It Helps You Prioritize Documentation and Behavior

Different credits reward different actions:

• Raising and supporting children
• Working and earning income
• Pursuing education
• Making certain energy or retirement-related choices

Knowing which credits you’re aiming for tells you:

• Which receipts and records to keep
• Which choices to prioritize
• When to coordinate with a spouse, ex-spouse, or business partner to maximize total household benefit

Credits + Deductions = Your Tax Strategy Engine

Don’t think of deductions and credits as competing tools—they’re teammates.

A strong tax strategy often includes:

• Deductions to lower your taxable income
• Nonrefundable credits to knock down your tax liability
• Refundable and partially refundable credits to potentially create refunds and improve cash flow

This is where we move from “What’s my refund?” to:

“How do I legally engineer my income, deductions, and credits so my family keeps more of what we earn over the next 5, 10, 20 years?”

That’s a different level of thinking—and it’s where real wealth-building begins.

Final Thoughts: Stop Leaving Credits on the Table

Here’s what I see all the time:

• People missing credits they qualify for because they don’t know they exist.
• People claiming credits without understanding how they interact with their income and deductions.
• DIY filers trusting software questions they don’t fully understand.

The tax code is not designed to be intuitive. But once you understand the types of credits and how they work, you can start playing offense instead of defense.

If you want help:

• Identifying which credits you qualify for
• Understanding whether they’re nonrefundable, refundable, or partially refundable
• Building a year-round strategy so you’re not leaving money on the table

…that’s exactly what my team and I are here to do for you.

🔗 Read more at: https://thecrgroupllc.com/financial-horizons

📅 Ready to put tax credits to work for you instead of guessing?
Book a consultation with Dr. Cardenas

About the Author

Dr. Jose G. Cardenas is a retired U.S. Army Finance Officer and the Chief Tax Strategist at The C & R Group, LLC. With a Doctorate in Business Administration and over 20 years of experience in tax planning and financial strategy, Dr. Cardenas helps individuals, families, and business owners legally reduce taxes, maximize credits and deductions, and build long-term wealth and legacy. Learn more at www.thecrgroupllc.com

📌 Disclosure

This article is for educational and informational purposes only and is not intended to serve as personalized legal, tax, or investment advice. Rules governing specific tax credits—including eligibility, refundability, phaseouts, and income thresholds—are complex and subject to change. You should consult with a qualified tax professional or review official IRS guidance for the current tax year before making decisions. Dr. Jose G. Cardenas, DBA, provides tax advisory services through The C & R Group, LLC. Insurance and investment strategies may be offered through his role as a licensed financial professional affiliated with Experior Financial Group.

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