NOTE: I wrote this post in 2014, so be aware of its age.
In Part 2 of this series, I want to explain more about the tax calculation and how getting a tax refund doesn’t necessarily mean you “didn’t owe taxes.”
In Part 1, I explained the tax calculation:
This is highly simplified but I think it covers the basics well enough. Here’s how the tax calculation works:
Minus student loan interest, if any
Minus standard deduction or itemized deductions
Minus personal exemptions
Equals taxable income
Next, you calculate the amount of tax owed on your taxable income.
To clarify: you calculate your gross tax owed before any credits are taken into consideration.
Once you’ve calculated your gross tax, you subtract out non-refundable credits. These are things like:
- The child tax credit
- The credit for daycare expenses
- The Lifetime Learning Credit
- Part of the American Opportunity education credit
- The credit for energy efficient windows and doors
Non-refundable credits cannot drop your tax liability below zero.
Next, you add any additional taxes, such as self-employment tax. This gets you to your “total tax.”
From your total tax, you subtract your refundable credits. These are things like:
- Withholding from your paycheck
- Estimated tax payments
- The earned income credit
- The refundable portion of the American Opportunity Credit
- The refundable portion of the child tax credit
Refundable credits are how you end up with a refund.
So if you get a refund, it’s possible that you “didn’t owe taxes,” but only if your “total tax” before refundable credits equaled zero.
John’s total tax is $1,000. His refundable credits total $1,500. John will get a refund of $500, but it’s not accurate to say John “didn’t owe taxes.” He owed $1,000 of taxes for the year but because of his refundable credits, he got a $500 refund when he filed his return.