Refundable Tax Credits Explained: Boost Your Tax Refundable Credits
What are refundable tax credits, and how are they different from tax deductions? In this article, we’ll discuss the various types of tax credits and common refundable tax credits. This guide can help taxpayers obtain the maximum refund they’re eligible for.
Tax credits are a crucial aspect of tax law as they directly reduce the amount of tax owed, unlike deductions, which lower the taxable income. Understanding the different types of tax credits and how they work can significantly impact your tax liability and refund.
What Are Refundable Tax Credits?
A refundable tax credit is a refund you can obtain even if you don’t owe the government any tax. Tax credits are amounts you subtract from your bottom-line tax due when filing your tax return. Most tax credits can lower your taxable until it becomes $0, while refundable credits allow you to obtain the remaining amount as a refund.
This dollar-for-dollar reduction in tax liability can result in a possible refund even if your tax liability is zero. That’s why people who qualify for this refund should take advantage of this tax benefit. There are three elements in this type of tax credit:
- It reduces tax liability to zero (if applicable)
- The excess credit amount is refunded to the taxpayer
- It’s not limited by the amount of taxes owed
This tax credit can be advantageous, especially to low-income taxpayers, because it provides a financial boost and is a form of negative income tax. In short, it allows you to make money without having to pay taxes.
All tax credits have eligibility criteria for receiving them. Some standard requirements include income level, family size, and earning some income. However, the availability of these credits is not always guaranteed. Congress decides their availability. If qualified, you can obtain this benefit by filing your taxes.
Difference Between Tax Credits and Tax Deductions
Tax credits and tax deductions can lower your overall tax bill but in different ways. The main difference between the two is that tax credits reduce your tax liability directly, while tax deductions reduce the income amount subjected to taxes. Tax credits are considered more attractive to taxpayers because they directly reduce the taxes you owe the government. Meanwhile, the tax deduction’s effects depend on your marginal tax bracket.
You don’t have to necessarily choose between tax credits and deductions when filing your taxes. If you’re qualified for both benefits for the same expenses, you can maximize your tax break at tax time.
Types of Tax Credits
There are three types of tax credits: refundable, nonrefundable, and partially refundable tax credits.
Nonrefundable Credits
These amounts are directly deducted from your tax liability until they turn 0. Any amount over the taxes owed isn’t paid out as a refund. These credits are valid for the tax year in reporting only, expire after the return is filed, and won’t carry over to future years. This tax credit can be disadvantageous to those with lower incomes because they won’t always get to maximize them.
Refundable Credits
These amounts are the most advantageous because you receive the total amount. You’re entitled to the full credit regardless of income or tax liability. This is why this credit is regarded as attractive to low-income individuals.
Partially Refundable Credits
Some credits are only partially refundable, meaning you can only get a refund up to a certain amount or percentage. While this credit doesn’t always guarantee that you’re entitled to a considerable refund, there’s still a possibility of getting something if you qualify.
Refundable Tax Credits vs Nonrefundable Credits
Refundable credits can result in a refund beyond the taxes paid to the government because the total amount is available to the qualified taxpayer. This characteristic is why this credit benefits those with low or no tax liability.
Meanwhile, nonrefundable tax credits are limited to the amount of taxes owed. They can’t reduce your tax liability to beyond 0. Because of this characteristic, the remaining amount is lost. You forfeit the rest of the credit because you don’t have any more taxes to be reduced.
Let’s say you owe $1000 in taxes and qualify for tax credits worth $1,500. If the tax credit is refundable, you can get the remaining $500 as a refund, but if it’s nonrefundable, you’d have to forfeit that amount.
6 Common Refundable Tax Credits
Various tax credits are available, but we’ll discuss the most common ones many taxpayers qualify for.
1. Earned Income Tax Credit (EITC)
This credit helps low—to moderate-income workers and their families obtain a tax break. The credit amount you’re owed may change if you have dependents, children, or meet other criteria. To qualify, you must have worked in the year when you’re claiming the credit, earned at least one dollar, and your income should be below a certain threshold.
You don’t necessarily have to have a child to obtain this credit, but having one or more can increase the amount you’re owed. The maximum credit you can receive if you don’t have any children is $632 for the 2024 tax year. This increases to $4,213 if you have one child, $6,960 if you have two, and up to $7,830 if you have three or more kids.
2. Additional Child Tax Credit (ACTC)
The Additional Child Tax Credit is the refundable portion of the Child Tax Credit (CTC). This credit allows you to claim up to $1,600 per kid ($1,700 for the 2024 tax year) as a refund when you file your taxes. Because of this credit, you can potentially obtain more money even if the Child Tax Credit can’t reduce the taxes you owe to below 0.
The ACTC applies when the CTC lowers your tax liability to 0; some money remains in the credit. Eligibility for the credit depends on your income level and work situation. The filer must report at least $2,500 in earned income for the tax year, but this requirement is waived for those with three or more children.
3. American Opportunity Tax Credit (AOTC)
American Opportunity Tax Credit, or AOTC, is a credit for qualified education expenses paid for by an eligible student for the first four years of higher education. This partially refundable tax credit grants a maximum annual credit of $2,500 per student, 40% (or up to $1,000) of which can be refunded.
To qualify for the AOTC, you must have been enrolled for at least one academic period for the tax year you’re claiming. You must also have completed your first four years of higher education, and you can only claim this four times per student.
4. Premium Tax Credit
Premium Tax Credits can help lower insurance premiums when you enroll in a health plan through the Health Insurance Marketplace.
You can receive this credit before filing your return by computing your expected income for the tax year when applying for coverage. The amount you’re owed depends on your income and household information. Your estimated income should be between 100% and 400% of the federal poverty level for your family size to qualify for this credit.
5. Recovery Rebate Credit
The Recovery Rebate Credit only applied during the 2020 and 2021 tax years. To put things into perspective, the IRS issued first, second, and third Economic Impact Payments, and those who received these checks aren’t eligible for this credit. Those missing payments or receiving less than the total amount may be eligible for this for their 2020 and 2021 tax returns.
6. R&D Tax Credit
Technically, Research and development tax credit is exclusively available to businesses that conduct research and development activities in the country, but this may interest business owners looking to lower their tax liabilities.
This credit provides a dollar-for-dollar reduction for qualified research expenses. While this is a federal benefit, select states offer additional incentives to encourage companies to invest in research and development.
Who is Eligible for Refundable Tax Credits?
Each tax credit has its own standards for eligibility, but in general, these factors can affect one’s capability for claiming tax credits:
- Income thresholds
- Filing status
- Number of dependents
- Education status (for education credits)
The IRS Interactive Tax Assistant can help determine if you qualify for tax credits.
Benefits of Refundable Tax Credits
Maximizing tax credits can help you reap plenty of benefits, including the following:
Reduced tax liability
You can reduce your tax liability to below 0 if you qualify for certain credits.
Increased refund
You can receive extra money because of these credits.
Financial support for low-income families
Most tax credits favor low-income families and can help finance one’s expenses.
Higher education
Education-focused credits lower one’s student loan debts by making higher education more affordable.
Economic stability
These credits empower people to afford their daily expenses, which can support economic stability.
How to Claim Refundable Tax Credits?
Follow these steps if you’re interested in claiming refundable tax credits:
- Gather necessary documentation. The requirements vary per tax credit. You need to provide supporting documents to justify your application.
- Determine eligibility for specific credits. Each credit has its own eligibility criteria.
- Complete relevant tax forms. You must submit tax forms related to the tax refund you’re applying for.
- Double-check calculations and entries. Ensure that all calculations are correct to prevent scrutiny.
- Submit tax return (e-file or mail). You can submit tax returns online or through mail.
Common mistakes when claiming credits:
You can spare yourself from potential trouble by steering clear of the following common pitfalls:
- Incorrect income reporting
- Missing or inaccurate Social Security numbers
- Misunderstanding eligibility criteria
- Importance of accurate reporting to avoid audits or delays
Claim Refundable Tax Credits with Professional Help
Not all tax credits are refundable, but if you are qualified for one or more, you should maximize them to lower your overall liability and potentially add to your budget. To ensure you don’t miss out on any pertinent details, seek professional help from a CPA professional. Sign up today to learn more.
FAQs
What is an example of a refundable tax credit?
Earned Income Tax Credit and Additional Child Tax Credit are two examples of refundable credits you can apply for. The more children you have, the bigger amount you can receive.
How do refundable tax credits save you money?
These credits can lower your overall tax bill so that you can allocate your funds to other expenses. While you may have to wait until your tax return to obtain the money, you can save plenty in the long run.
What is the difference between refundable and nonrefundable child tax credits?
The refundable portion refers to the amount you’re owed if your taxes are reduced to 0 after computing the Child Tax Credit. The nonrefundable portion of the Child Tax Credit is the original credit that can lower your overall taxes.
How do tax credits work?
Tax credits can lower your tax liability by providing a refund if you’re eligible. Some credits are nonrefundable, while others are partially refundable and refundable.
Do you get money back for a tax credit?
If the credits are refundable or partially refundable, you can get money back. Otherwise, you forfeit the rest of the credits.
Are tax credits worth it?
Yes, if you qualify for tax credits, you can lower your taxes owed to the government while possibly receiving extra funds.
How to get a $10,000 tax refund?
This would depend on your income return, but you can try applying for several tax credits to increase the money you’re granted.
Which is better, a refundable or a non-refundable credit?
A refundable tax credit is better because you can earn money from the credit instead of a nonrefundable one that can only reduce your taxes to 0.
How does a tax credit work if I don’t owe taxes?
If you’re a student, you can still apply for tax credits if you satisfy its requirements. However, you must provide sufficient evidence that you’re qualified for the credits you claim.