Q. This may be a stupid question, but I just want to be sure. Between the $1,700 tax credit for the hybrid I will receive, as long as it is delivered by 9/30/08, and the sales tax credit of about $2,900 I will exceed my total tax liability for the year. In addition, because of my medical expenses, and I am having dental work done now also, property taxes, new home equity interest, and the usual I will have lots of deductions. If I exceed my tax liability will I still receive the balance of the tax credits as a refund? If not, I could always cash in some more bonds.
A. There is no such thing as a stupid tax question – only stupid taxpayers (who don’t consult a competent tax professional)! The question actually brings up an excellent tax-planning point.
First of all, the “sales tax credit of about $2,900” to which he refers is not actually a credit (a credit is a dollar-for-dollar reduction of tax liability). He is talking about the “above the line” tax deduction for sales or excise taxes paid on the purchase of a new automobile. His Adjusted Gross Income (AGI), and not his tax liability, will be reduced by $2,900. He also mentions excessive medical expenses, so the $2,900 “above the line” deduction will increase his allowable medical deductions by $218!
He is basically asking if the $1,700 energy tax credit for purchasing a hybrid car reduces his tax liability to below “0” will he be able to receive a refund of the unused credit. The answer is no.
Most tax credits are not “refundable”. Only the Earned Income Credit, BO’s new Making Work Pay Credit, a portion of the new American Opportunity Credit for tuition and fees, and possibly the Child Tax Credit are “refundable”. By “refundable” I mean they are treated as additional withholding and can be applied against “other” taxes, such as the self-employment tax and the penalty for early withdrawal from a pension account, and ultimately added to the taxpayer’s refund.
In the case of my friend – he is single with no children, recently retired (late 2008) - though not receiving Social Security or Railroad Retirement - and will be reporting some nominal net earnings from self-employment for 2009. The only “refundable” credit to which he will be entitled is the Making Work Pay credit, which is based on 6.2% of his self-employment income. The MWP credit can be applied against his self-employment tax for the year.
However with reduced income due to retirement and excessive deductions due to special situations it is very possible that the $1,700 hybrid credit will exceed his federal income tax liability. In such a case the excess hybrid credit would be lost.
In this particular case the taxpayer has a large “inventory” of US Series E savings bonds, both purchased and inherited, that are still earning interest. He plans to cash in a certain amount each year, determined by tax planning, to supplement his income until Social Security kicks in. He has already cashed in the bonds scheduled for 2009.
What we will do is prepare a “preliminary” 2009 tax return in late November or early December as part of regular year-end tax planning. If at that time we determine, based on year-to-date information, that his tax liability before the hybrid credit will be less than $1,700 he will cash in enough additional savings bonds to generate the amount of taxable interest income needed to use up the excess credit. By doing this the additional savings bond interest will be totally tax free (US savings bond interest is already tax free on the NJ-1040)!
FYI, my friend and client uses the Savings Bond Wizard software available online to properly “inventory” his bonds so that he knows how much interest each bond will accrue for the year.