There are two types of tax credits available for taxpayers: refundable and nonrefundable. Both types offer you the chance to lower the amount of taxes you owe, but refundable credits can also get you a tax refund when you don't owe any tax.
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When filing their income taxes each year, taxpayers may have different goals in mind. Some may want to lower the amount of taxes they owe, seek the largest refund possible or avoid paying more in taxes than they are legally required to pay. Tax credits can help you meet all of those goals.
There are two types of credits available for taxpayers: refundable and nonrefundable.
- Both types of credits offer you the chance to lower the amount of taxes you owe.
- Refundable tax credits can also get you a tax refund when you don’t owe any tax.
Refundable credits can provide you with a refund
Refundable tax credits are called “refundable” because if you qualify for a refundable credit and the amount of the credit is larger than the tax you owe, you will receive a refund for the difference.
- For example, if you owe $800 in taxes and qualify for a $1,000 refundable credit, you would receive a $200 refund.
- Like payroll withholding, refundable tax credits are regarded as tax payments. This means that the amount of a refundable tax credit is subtracted from the amount of taxes owed, just like the amount of tax you had withheld from your paycheck.
- With some of the larger refundable credits, like the Earned Income Tax Credit, the amount of your refund can be substantial. This makes refundable credits some of the most valuable parts of your tax return.
Even with zero tax liability, you may still qualify
Some taxpayers may find that nonrefundable credits, deductions or other circumstances leave them with zero taxes due. Even with no taxes owed, taxpayers can still apply any refundable credits they qualify for and receive the amount of the credit or credits as a refund.
- For example, if you end up with no taxes due and you qualify for a $2,000 refundable tax credit, you will receive the entire $2,000 as a refund.
- For this reason, when doing your taxes, consider calculating any refundable tax credits after figuring in all nonrefundable credits, deductions and tax payments.
Each credit has different qualifications
All tax credits come with a set of qualifications that the taxpayer needs to meet in order to receive the credit. Some common requirements include:
- an income level within a certain range,
- family size, or
- a requirement that the taxpayer had some earned income.
While some credits are specifically for lower-income taxpayers, others have much higher income thresholds. Many of the credits even have a step scale in which taxpayers with lower incomes are eligible for a larger credit than taxpayers at the higher end of the income scale.
Available credits change from year to year
Whether or not a tax credit is available every year is not guaranteed. Each year, Congress has the opportunity to extend many of the tax credits available the previous year.
- Some credits are created as part of a stimulus plan to help boost the economy and, therefore, are set to expire after a limited number of years.
- If Congress chooses not to extend a credit, the credit expires.
- One example of this is the Making Work Pay Credit, which offered a refundable credit of $400 for individuals and $800 for couples married filing jointly. It was available in tax years 2009 and 2010, but because Congress did not vote to extend it, the credit is no longer available.
Congress can change the rules
When deciding whether to extend a tax credit or allow it to expire, the federal government sometimes compromises by altering the terms of the credit, making it worth more or less than it had been in previous years.
For example, the First-Time Homebuyer Credit created in 2008 was originally worth up to $7,500 with the requirement that the taxpayer repay a portion of it each year. Instead of allowing it to expire at the end of 2008,
- The First-Time Homebuyer Credit was extended and altered for homes purchased in 2009 and 2010.
- The altered credit was worth up to $8,000 and did not have to be repaid unless the homebuyer sold or moved out of the home.
The federal government can also alter the terms of the credit. For example,
- the credit could change from being refundable to nonrefundable, or
- the qualifications for the credit could change, altering the number of people who will be able to take advantage of the credit.
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