My business grossed $8000 in 2024 and had deductions adding up to $15000. Could the IRS end up sending me a refund for around $7000?
It would be nice but, alas, the answer is no.Simply put (for this example), a tax deduction is not a tax credit.A tax deduction reduces your taxable INCOME.A tax credit offsets income TAX otherwise due.A u201crefundableu201d tax credit offsets income TAX otherwise due, and if there is any credit value left over, the balance is paid out to you as a cash check from the Treasury. Woohoo.Some simplified examplesu2026Deductions:Business revenue of $8,000 and expenses of $15,000. Net income equals -$7,000. Expenses are deductible only to the extent they fully offset revenue. So taxable income for the year is $0. You pay no income tax. However, the -$7,000 of unused expenses (e.g. your net loss for the year), can be carried into next year, and you can deduct it then. So, in Year 2 assume business revenue of $8,000 again and expenses of only $1,000. Net income equals $7,000. You can use the prior yearu2019s loss of -$7,000 to deduct against the current yearu2019s income, reducing net taxable income from $7,000 to $0. This is called u201closs carry-forwardu201d. You can also u201ccarry-backu201d to a prior year but I want to keep the example simple. The reason for these rules is to help ensure business income taxes are smoothed out/averaged over the course of 3u20135 years of business income. That way if you lose money in Y1,2,3, make excessive profit in Y4 and go back to losses in Y5, you aren't stuck with a huge income tax bill in Y4 even though overall your business is barely scraping by.Credits:My example business is in Australia. I have income of $200k and expenses of $100k. Net income is $100k. I paid Australian income tax of $30k on my net income. I file with the IRS and they see my revenue and my deductible expenses and they see that I made taxable income of $100k. They see on the return that I owe them ~$24k in income taxes based on my income (for example). However, they also see that I already paid $30k of tax on that income in Australia. This enables me to claim a Foreign Tax Credit. The FTC is not a deduction. It is better, since it lets me credit the US tax due dollar for dollar against the AU tax already paid. I owe no US tax in this example. Since taxes are higher in Australia there are even extra tax credits left over at the end, which I can carry forward into the next year.Now assume Australia cuts its tax rates in half. Now I only paid $15k in AU taxes, which is less than the $24k I owe the US. I still get to apply the credit ($24k-$15k=$9k), but I now have to pay the IRS the $9k difference to meet my US obligation.Refundable Tax CreditsRefundable tax credits work the same way as normal tax credits, but instead of carrying any excess credits forward into a new year, the government just pays the credit to you as cash. This is really just another type of transfer payment, also known as welfare and/or income re-distribution. Since you're being u201crefundedu201d more than you paid in taxes it's not really a refund at all. You are simply the welfare recipient of the taxes being paid by your neighbor. See President Nixonu2019s Negative Income Tax proposal for a clearer application of this idea.
