Refundable tax credits

Key takeaways

• Tax credits are dollar-for-dollar reductions in the amount of taxes you owe.
• Refundable tax credits reduce the amount of any taxes you owe and may also boost your tax refund. Nonrefundable tax credits allow you to reduce your income tax bill, but only up to the amount you owe.
• The Earned Income Tax Credit (EITC) is refundable and was designed to help low- to moderate-income workers and families.
• The Child Tax Credit (CTC) is partially refundable and is designed to help offset the costs of raising children.
• The American Opportunity Tax Credit (AOTC) is partially refundable and is designed to help students and families manage the costs of higher education.
• The Electric Vehicle (EV) Tax Credit is nonrefundable and offers a significant incentive for consumers looking to purchase electric cars.
• The Residential Clean Energy Tax Credit is nonrefundable and is designed to encourage homeowners to invest in renewable-energy systems.

What are tax credits?

Think of a tax credit as a dollar-for-dollar reduction of the amount of taxes you owe to the government. It's like having a coupon that you can use to pay part of your tax bill

What’s the difference between deductions and tax credits? Deductions are “top-line,” which means that they’re taken out after you reduce the amount of your income that can be taxed and before you calculate your taxes. On the other hand, tax credits are “bottom-line,” which means they are taken after you calculate your taxes, and directly reduce the amount of income taxes you owe.

You can use both tax credits and deductions to lower your tax bill or increase your refund. However, some credits are refundable, and others are not.

What are refundable tax credits?

Refundable tax credits not only reduce the amount of tax you owe but also have the potential to boost your tax refund. This means that if a refundable tax credit is larger than your total tax bill, you'll get the difference back as a refund.

For example, if you owe $500 in taxes and qualify for a $1,000 refundable tax credit, instead of paying $500, you will owe nothing and receive $500 back as a refund.

Some of the largest credits are part of the government's strategy to provide financial relief to families and individuals who need it most. By directly increasing tax refunds, these credits can help cover essential expenses like housing, food, and childcare.

Refundable tax credit example

Refundable vs. nonrefundable tax credit

Understanding the difference between refundable and nonrefundable tax credits can help you better plan your finances, especially when it comes to tax time. Both types of credits can reduce the amount you owe in taxes, but the way they work, and their impact on your finances, can be quite different.

Nonrefundable tax credits allow you to reduce your tax bill, but only up to the amount you owe. For instance, if you qualify for a $1,000 nonrefundable tax credit but only owe $700 in taxes, you'll owe nothing. However, you won't get the remaining $300 back. The credit can only bring your tax liability to zero, no further.

While nonrefundable tax credits are a “use it or lost it” situation, although some of them can be carried over into future years. That means that, using the above example, the remaining $300 could be used to lower your tax bill next year by $300.

Refundable tax credits can provide a significant financial boost by potentially increasing your tax refund, which can help with everyday expenses or emergency savings. On the other hand, nonrefundable credits only ensure that you pay less in income taxes, which, while beneficial, does not offer the same potential for a financial uplift as refundable credits.

Nonrefundable tax credit example

If you have any additional taxes, such as self-employment taxes or the additional 10% tax for an early withdrawal from your IRA or retirement plan, you should see a Tax Pro.

Is the Earned Income Tax Credit refundable?

Yes, the Earned Income Tax Credit (EITC), which is designed to offset the Social Security and Medicare withholdings and help low- to moderate-income workers and families, is indeed refundable. If the credit amount you qualify for exceeds any remaining taxes you owe, you will receive the difference as a refund.

For example, if your remaining taxes (after the nonrefundable credits) have you owing $1,000 in taxes and you qualify for an EITC of $2,500, you won't just zero out your tax bill; you'll also add $1,500 to any refund.

This makes the EITC particularly valuable for eligible taxpayers because it can provide a substantial financial boost well beyond just reducing tax liability to zero. By providing a refund that can exceed taxes owed, the EITC helps cover everyday living expenses, reduce debt, or save for future needs.

Is the Child Tax Credit refundable?

Yes, the Child Tax Credit (CTC), can be refundable. In 2024 up to $1,700 per child can be refundable. What about the $2,000 per child? The child tax credit is a nonrefundable and refundable credit. In 2024, $300 per child can only be used as a nonrefundable credit. It is intended to help offset the costs of raising children. If the credit amount exceeds the taxes you owe, you can receive some or all the difference, up to $1,700 per child as a refund.

The refundable portion of the CTC is known as the Additional Child Tax Credit (ACTC), and the exact refundable amount depends on your circumstances.

Is the American Opportunity Tax Credit refundable?

Yes, the American Opportunity Tax Credit (AOTC), which is designed to help students and families manage the costs of higher education, is partially refundable. If the credit reduces the amount of taxes you owe to zero, you can still receive a refund of 40% of the remaining amount of the credit up to a maximum of $1,000 per credit.

For example, if you qualify for the full AOTC of $2,500 and have no tax liability, you must use the first 60% of the credit up to $1,500 as a nonrefundable credit with the balance, up to $1,000 as a refund.

This partial refundability makes the AOTC a valuable credit for college students and their families. It not only reduces the tax burden but also provides a cash refund that can help cover other educational expenses like books, supplies, and living costs. The refundable portion of the AOTC can be particularly beneficial for students with lower income, as it helps make education more accessible and affordable.

Is the EV Tax Credit refundable?

No, the Electric Vehicle (EV) Tax Credit, which is worth up to $7,500 and offers a significant incentive if you are looking to purchase electric cars, is not refundable. This means that the credit can reduce your tax bill to zero, but you won't receive a refund if the credit exceeds the amount of income taxes you owe.

For example, if you qualify for a $7,500 EV Tax Credit and your income taxes for the year are $5,000, you will not have any income taxes, but you will not receive the remaining $2,500 as a refund.

This nonrefundable nature of the EV Tax Credit limits its immediate financial benefit to only those tax years in which you owe taxes. If your tax liability is less than the credit amount, you cannot carry over the unused portion to future tax years. It's a use-it-or-lose-it benefit for the year in which you purchase the eligible vehicle.

Is the Residential Clean Energy Credit refundable?

No, the Residential Clean Energy Credit, which is designed to encourage homeowners to invest in renewable-energy systems, such as solar panels, wind turbines, geothermal heat pumps, and solar-powered water heaters, is not refundable.

The Residential Clean Energy Credit is a nonrefundable credit that can reduce your income tax liability to zero, but you won't receive any of the credit’s value back as a refund if the credit exceeds the amount of income taxes you owe.

For example, if you qualify for a $4,000 clean energy tax credit after installing solar panels, and your income tax liability for the year is $3,000, you will not owe any taxes, but you will not receive the remaining $1,000 of the credit as a refund.

However, you can carry over the Residential Clean Energy Credit to future tax years until it’s completely used. In the example above, the $1,000 remaining could be used to reduce your tax bill by $1,000 when you file next year.

Though the Residential Clean Energy Credit does not provide a refund beyond reducing your tax liability to zero, it can provide a refund based on not using your withholding and refundable credits to reduce your income taxes. The credit also presents significant financial savings and lowers the initial cost barrier of installing renewable energy systems. Additionally, the savings on energy bills over time, thanks to renewable energy systems, offers ongoing financial benefits.

Taking advantage of tax credits, especially refundable ones, can reduce your tax bill or increase your refund.

Given the complexity of tax laws and the criteria required to claim these benefits, it’s smart to work with a Tax Pro who can help you navigate the intricacies and ensure you’re getting every credit you deserve.

Remember, when it comes to taxes, every bit of savings counts, and the right advice can lead to significant benefits.