What Is a Refundable Credit?
A refundable credit is a tax credit that is refunded to the taxpayer no matter how much the taxpayer's liability is. Typically, a tax credit is non-refundable, which means that the credit offsets any tax liability the taxpayer owes, but if the credit takes this liability amount down to zero, no actual money is refunded to the taxpayer. In contrast, refundable credits can take the tax liability down below zero and this amount is refunded in cash to the taxpayer.
- Refundable tax credits are refunded to the taxpayer regardless of the taxpayer's liability.
- These tax credits are called refundable because they can involve cash payments from the IRS if they put the taxpayer's lability below zero.
- Some types of taxes cannot be offset by non-refundable taxes and can only be offset by certain refundable taxes, such as self-employment tax and tax on premature distributions from retirement accounts.
- The earned income credit is one example of a refundable credit that can offset taxes that cannot be offset by non-refundable credits.
Understanding Refundable Credits
A refundable credit is called refundable because the taxpayer can receive a payment from the U.S. government through the Internal Revenue Service (IRS) if the credit puts the taxpayer's tax liability into the negative numbers. This differs from a non-refundable credit, which can reduce the taxpayer's liability down to zero, but that is the limit. No money can be refunded to the taxpayer, no matter how much of the tax credit is left after the liability hits zero.
A taxpayer can claim a refundable credit that is larger than their tax liability, and the IRS will send them the balance of the credit. A taxpayer with no tax liability cannot use a non-refundable tax credit because a non-refundable tax credit cannot take a liability balance below zero. A taxpayer with no tax liability, however, can use a refundable tax credit—no matter how large or small the credit is—and will be refunded the full balance of money credited. It thus makes sense for a taxpayer to calculate all their taxes already paid, deductions, and nonrefundable credits, and then calculate and apply any refundable credits.
Qualifying for Refundable Credit
Whether non-refundable or refundable, tax credits have detailed, specific sets of qualifications a taxpayer must meet to be eligible for. These qualifications may include things like income level, family size, occupation type, investment or savings type, earned income, and other specific situations.
Credits may be structured as single amounts, percentages of income or tax liability, or some other number or a step scale in which taxpayers with lower incomes get a larger credit than taxpayers with higher incomes do.
Some types of taxes cannot be offset by non-refundable taxes and can only be offset by certain refundable taxes. The self-employment tax and tax on premature distributions from retirement accounts are examples of taxes that cannot be offset by all types of credits.
The earned income credit is one example of a refundable credit that can offset taxes that cannot be offset by non-refundable credits.