5 Things You Should Know about Refundable Tax Credits
Refundable tax credits not only reduce your tax bill on a dollar-for-dollar basis, but they can also generate a tax refund if the tax you owe before applying any credits is less than the credit amount (unlike nonrefundable credits, which can only reduce your tax bill to $0). Here’s a few things every taxpayer should know about refundable tax credits.
Key Takeaways
- Refundable tax credits can generate a tax refund if they exceed the amount of tax you owe, whereas nonrefundable credits can only reduce your tax bill to zero without triggering a refund.
- The most common refundable tax credits are the Earned Income Tax Credit, Child Tax Credit, American Opportunity Tax Credit, and the Premium Tax Credit.
- Even if you’re not required to file an income tax return, you must file a return to claim a refundable tax credit and receive any related tax refund.
- Refundable tax credits are subject to change each year, including adjustments for inflation and potential legislative changes that can impact your eligibility for and the amount of the credit.
What is a refundable tax credit?
Federal income tax credits help you cut your tax bill and, in some cases, can even generate a tax refund. In fact, tax credits are one of the best tax breaks around, because they’re applied directly against the tax you owe on a dollar-for-dollar basis (as opposed to tax deductions, which only reduce your tax bill by a certain percentage).
There are two types of federal income tax credits: refundable and nonrefundable credits. Both types of credits lower the amount of tax you owe. However, nonrefundable tax credits can only reduce the tax you owe to zero. They won’t generate a tax refund if the credit exceeds the amount owed. On the other hand, refundable tax credits can trigger a refund if the credit amount is greater than the tax you would owe before the credit is applied.
To illustrate the differences between refundable and nonrefundable credits, assume you owe $2,000 in tax before applying any tax credits. If you have a $2,500 nonrefundable credit, the first $2,000 of the credit is subtracted from the tax you owe – which reduces your tax bill to $0. But that’s the only tax benefit you get (at least for that year). The remaining $500 of the credit ($2,500 – $2,000 = $500) can’t be used to generate a tax refund (although you might be able to carry it forward and use it on a future tax return).
However, in the example above, if you have a $2,500 refundable credit, you’ll also get a $500 tax refund. As with a nonrefundable credit, the first $2,000 of the refundable credit is subtracted from the tax you owe – resulting in a $0 tax bill. But then you get the remaining $500 of the credit back as a refund. That way, you get the full benefit of the credit.
What are the most common refundable tax credits?
Millions of people claim refundable tax credits each year on their federal income tax returns. The four most common refundable credits are:
Earned Income Tax Credit
The Earned Income Tax Credit is available to low- and moderate-income workers. To qualify for the credit, you must have earned income – such as wages, salary, or tips. However, if your earned income is over a certain amount, the credit is gradually reduced (potentially to $0). The credit amount is also higher if you have qualifying children.
Child Tax Credit
For both the 2024 and 2025 tax years, the Child Tax Credit is worth up to $2,000 for each qualifying child, but the credit is phased-out if your income exceeds a certain amount. To be a “qualifying child,” your child must be 16 or younger at the end of the year, have a Social Security number, live with you for more than half of the tax year, and satisfy several other requirements.
American Opportunity Tax Credit
The American Opportunity Tax Credit helps cover some of a student’s costs for the first four years of college. The credit is worth up to $2,500 per eligible student, but it’s gradually phased-out if your income is above a certain amount.
Premium Tax Credit
The Premium Tax Credit is available to low- and moderate-income people who purchase medical insurance through a Health Care Marketplace. You can choose to have the credit paid in advance directly to your insurance provider. This will reduce the amount you have to pay each month for the insurance. However, if you select the advance payment option, you must file a federal income tax return to reconcile the allowable credit amount with the advance payments.
Refundable Tax Credits: What to Know
Refundable tax credits not only help you cut your tax bill to the bone, but they can also trigger a tax refund (or larger refund). That’s why they’re so valuable. To help you take advantage of them whenever you can, here are five other things you should know about refundable tax credits.
- Some credits are only partially refundable
Some federal tax credits – such as the Child Tax Credit and American Opportunity Tax Credit – are only partially refundable. In this case, the credit is split into a nonrefundable portion and a refundable portion.
TurboTax Tip:
The refundable portion of the Child Tax Credit is called the Additional Child Tax Credit.
The nonrefundable portion can’t reduce the tax you owe below $0, but there’s no such restriction with the refundable portion. For instance, suppose you owe $1,000 of tax before any credits are applied. You also have a $2,000 partially refundable credit – the nonrefundable portion is $1,500 and the refundable portion is $500. In this case, the first $1,000 of the nonrefundable portion will reduce your tax to $0, and the refundable portion will generate a $500 tax refund. The remaining $500 from the nonrefundable portion ($1,500 - $1,000 = $500) can’t be applied on that tax return (although you might be able to use it on a future tax return if it can be carried forward).
Also note that there are typically limits and/or restrictions on how much of a partially refundable credit can be treated as refundable. For example, the refundable portion of the American Opportunity Tax Credit can’t exceed 40% of the overall credit amount, and none of the credit is refundable in certain situations where the student is under 24 years old.
- Refundable credits have various requirements and limitations
While refundable credits can be very valuable, not everyone can claim them. Eligibility requirements are usually tight when it comes to refundable credits – and the rules differ from one credit to another. Many eligibility requirements for refundable credits are based on your income, filing status, or qualifying dependents.
In addition, refundable credits often have phase-out ranges based on your income, where the credit amount gradually decreases as your income increases beyond a certain threshold. For example, your Child Tax Credit is reduced – potentially to $0 – if your modified adjusted gross income exceeds $200,000 ($400,000 for married couples filing jointly).
You also may have to complete additional tax forms and/or provide supporting documentation to claim a refundable tax credit. For instance, the following forms must be completed in addition to your standard federal income tax form (Form 1040):
- Schedule EIC for the Earned Income Tax Credit if you have qualifying children
- Schedule 8812 for the Child Tax Credit
- Form 8863 for the American Opportunity Tax Credit
- Form 8962 for the Premium Tax Credit
- You have to file a tax return to claim refundable tax credits
The only way to claim a refundable tax credit – and get any related tax refund – is to file an income tax return. The IRS isn’t going to automatically send you a refund. As a result, even if you aren’t required to file a tax return, you should still file one if you qualify for a refundable tax credit.
That way, you can receive any tax refund you’re due. Yes, you’ll have to fill out all the necessary forms, but it will likely be worth the time and effort to get money back from the IRS. Otherwise, you’re walking away from money that’s rightfully yours and leaving it on the table.
- Your refund might be delayed if you claim certain refundable tax credits
If you claim the Additional Child Tax Credit or Earned Income Tax Credit on your return, payment of any tax refund you’re due might be delayed. That’s because the IRS is prevented by law from issuing refunds for these two refundable credits before mid-February. This applies to your entire refund – not just the part that’s related to the refundable credit you claimed on your return.
This requirement was established by the PATH Act to address the frequent errors, identity theft, and other methods of fraud associated with these two tax credits. The built-in delay gives the IRS more time to double-check early tax returns claiming these credits before issuing a refund.
So, if you file early and claim either the Additional Child Tax Credit or Earned Income Tax Credit, don’t expect any tax refund to be sent right away. However, each year the IRS typically announces a date that you can expect to receive your refund if you e-file, select direct deposit, and there are no issues with your return.
You can also track the status of your tax refund using the IRS’s online “Where’s My Refund” tool.
- Refundable tax credits can change each year
Just because you qualified for a refundable tax credit last year doesn’t necessarily mean you’ll qualify for the same credit this year (and vice versa). You also could be eligible for a larger (or smaller) refundable credit from one year to the next. That’s because the eligibility requirements, income limitations, and other aspects of the credits can – and often do in some cases – change from year to year.
The most consistent changes are to certain credit-related dollar amounts that are adjusted every year to account for inflation. These dollar figures can be associated with maximum credit amounts, income requirements, phase-out thresholds, refundability caps, and the like. For example, dollar amounts at which the Earned Income Tax Credit begins to phase out are typically increased each year to keep up with inflation. As a result, your credit might be reduced one year, but not the next.
Of course, Congress can make more substantial changes to refundable tax credits – including creating new ones and repealing existing ones. This doesn’t happen very often, but it’s still something to watch out for each year.
In some cases, amendments to the law governing a refundable credit are only temporary. So, you have to be aware of the expiration date of those changes. You should also check to see if the amendments have been extended or made permanent before they expire.
The bottom line is that you should keep an eye out for any changes or revisions to refundable tax credits that you claimed in the past, might be able to claim for the current tax year, or hope to claim in the future. That way, you won’t miss out on a change that benefits you.
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