One of the most confusing terms to those new to the tax game is refundable tax credits.
Most people have heard of refundable tax credits but are unsure how they work or how they can be of benefit.
We’re here to help explain and clear it up for you!
This article will give you the simplest definition of refundable tax credits and list the most common credits, and the criteria for receiving them..
Refundable tax credit definition
Firstly, let’s quickly go over what a tax credit is.
A tax credit directly reduces the amount of tax owed by a taxpayer. It’s an amount of money that is subtracted from the taxes they owe. There are two main categories of tax credits: refundable and nonrefundable. A refundable tax credit allows you to receive a payment from the IRS if your credits exceed your tax liability. On the other hand, a nonrefundable tax credit doesn’t generate a refund and can only reduce your taxes owed to $0.
To better visualize how a refundable tax credit works, take a look at the following example. Let’s say you owe $2000 in taxes this year but you’re also eligible for $3000 refundable tax credits. That means your $2000 tax liability will be eliminated, but you will also get a $1000 refund from the IRS. Yes, you can even ‘earn’ some money with refundable tax credits!
What tax credits are refundable?
Now that you understand how beneficial a refundable tax credit can be, let’s check out the most common refundable tax credits that you might be eligible for:
1. Child Tax Credit (CTC)
The CTC is a federal program that helps American families make ends meet, easing the costs of raising children, and to help prepare for their children’s future. Under the American Rescue Act of 2021, families could receive $3,000 per qualifying child under the age of 6 and $3,600 for those aged 6 to 17.
2. Earned Income Tax Credit (EITC)
EITC is a refundable tax credit for low- to moderate-income working taxpayers and couples, particularly those with children. The EITC benefit amount is determined by the recipient’s income and the number of children. For example, if you have three or more qualifying children and meet all other conditions, you can get a refund of up to $6,728.
3 . American Opportunity Tax Credit (AOTC)
AOTC helps students or their parents (if the student is dependent) pay for the first four years of education after high school with a credit of up to $2,500. One thing to note about this tax credit is that it’s only partially refundable—40% is refundable and is capped at $1,000, while the remaining 60% is nonrefundable.
4. Premium Tax Credits (PTC)
PTC is a refundable tax credit that helps low- and moderate-income people and families afford health insurance through the Health Insurance Marketplace. A sliding scale is used to determine the amount of your premium tax credit: those with a lesser income are given greater credit to assist in offsetting the cost of their insurance.
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