What is 'Refundable Credit'

A refundable credit is a tax credit that is not limited by the amount of an individual's tax liability. Typically, a tax credit only reduces an individual's tax liability to zero. Refundable credits go beyond this and so really can be considered the same as a payment.

BREAKING DOWN 'Refundable Credit'

Refundable credits are called refundable because they can reduce your tax liability below zero and allow you to receive a tax refund. By contrast, a nonrefundable tax credit can only reduce your federal income tax liability to zero. Any part of the credit that's left over is not refunded back to you. The Internal Revenue Service (IRS) keeps the money.

When a taxpayer is eligible to claim a credit that's refundable and it's more than their total tax liability, the IRS will send them the balance of the money. With refundable credits, the taxpayer can still use the credit even if they have no tax liability. 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. This means that if one ends up with no taxes due and they qualify for a $2,000 refundable tax credit, they will receive the entire $2,000 as a refund. For this reason, when doing taxes, one should calculate refundable tax credits after figuring in all nonrefundable credits, deductions and tax payments.

Qualifying for Refundable Credit

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 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.

Refundable tax credits can offset certain types of taxes that normally can't be reduced in other ways. They can help offset the self-employment tax, the surtax on early distributions of retirement savings, or even other surtaxes such as the nanny tax, the net investment income tax, or the additional Medicare tax. The earned income credit is a good example of a refundable credit in the United States.

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