Refundable Tax Credit

Refundable Credit is a tax credit that is refunded to the taxpayer regardless of the amount of the taxpayer's debt. A tax credit is often non-refundable, which means that it balances any tax liability owed by the taxpayer, but if the credit reduces this liability amount to zero, no actual money is refunded to the taxpayer. Refundable credits, on the other hand, can reduce a person's tax liability to zero and then reimburse the taxpayer in cash.

Understanding Refundable Credits

A refundable credit is so named because, in the event that it lowers the taxpayer's tax burden below zero, the IRS may make a payment to the taxpayer on behalf of the federal government.

This is distinct from a non-refundable credit, which has a maximum reduction in the taxpayer's liability of zero. No amount, regardless of the amount of the tax credit remaining after the liability is zero, may be returned to the taxpayer.

In the event that a taxpayer claims a refundable credit that exceeds their tax liability, the IRS will send them the remaining portion of the credit. A non-refundable tax credit cannot reduce a liability balance below zero, therefore a taxpayer who has no tax due cannot use it.

However, regardless of how big or small the credit is, a taxpayer who has no tax liability can use it and will be reimbursed for the entire amount awarded. Therefore, it makes sense for a taxpayer to first determine all of their already paid taxes, deductions, and non-refundable credits before determining and applying any refundable credits.

Types of Refundable Tax Credits

The Earned Income Tax Credit:

For low-income working individuals, there is the Earned Income Credit (EITC). To qualify, you must have earned income, but you are not allowed to have too much. For taxpayers who have three or more qualifying children, the maximum credit is $6,935 for the 2022 tax year ($7,430 for 2023).34

As you make more money or take on fewer dependents, the EITC lowers because it is based on income and the number of qualifying dependents. If your income exceeds a particular threshold, it is completely unavailable.

The Child Tax Credit:

For the 2022 tax year, each kid is eligible for a child tax credit up to a maximum of $2,000, of which $1,500 is refundable.

When a single filer's income surpasses $200,000 (or $400,000 for married couples filing joint returns), a phaseout threshold kicks in and starts to lower the value of these credits.

How Refundable Tax Credit works

The government will provide a person who qualifies for a refundable tax credit more money than they would otherwise owe in taxes.They qualify to be net receivers rather than paying taxes.

Let's imagine, for illustration purposes, that a person owes $100 in taxes but qualifies for a $150 refundable tax credit. The employee's tax obligation is decreased from $100 to $50, which means they will get $50 from the government rather than paying $100 in taxes. This essentially functions as a negative income tax.

Key takeaways

Regardless of the tax liability of the taxpayer, refundable tax credits are reimbursed to the taxpayer.

These tax credits are known as refundable because, in the event that they reduce the taxpayer's burden to zero, they may result in cash reimbursements from the IRS.

Certain refundable taxes, such as the self-employment tax and the tax on early distributions from retirement funds, are the only ones that can be used to offset certain taxes, which cannot be offset by non-refundable taxes.

A refundable credit like the earned income credit can be used to offset taxes that cannot be offset by non-refundable credits.