What Is A Refundable Tax Credit?

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.

Want to know more about finance? 

If you’d like to explore more entrepreneurship stories, get simple explanations of complex financial terms, or learn about the best productivity tools, find more posts like this on the Shoeboxed blog.

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

What Is Tax Credit? A Basic Guide To Tax Credits 

Many people know that tax credits can help lower the amount of tax money you owe to the IRS. 

But what exactly are tax credits? How do they work? 

Let’s scroll down to find out!

What is a tax credit? 

A tax credit is a dollar-for-dollar reduction in a taxpayer’s final tax bill.

Generally, a tax credit is created to promote or reward certain kinds of conduct that the government deems advantageous to the economy, the environment, or any other essential goal. For instance, you can claim a tax credit if you install solar panels for home use to save energy and protect the environment. 

How does a tax credit work? 

As previously mentioned, a tax credit lowers the income tax you owe dollar-for-dollar. What does that really mean? Well, take a look at this example: 

Suppose that you have to pay $2000 taxes and have a $2000 tax credit—that means your tax will be subtracted to zero, and you will be totally tax-free!

This is also what makes a tax credit different from a tax deduction. A $2000 tax deduction only lowers your taxable income (the amount of income on which you owe taxes), not your final tax bill, by $2,000. So, if you fall into the 22% tax bracket, a $2,000 deduction would save you $440.

What are the different types of tax credits? 

There are three types of tax credits: nonrefundable, refundable, and partially refundable. Below are brief explanations of each tax credit category:

1. Refundable tax credits

As the name suggests, you may get a refund from the IRS with refundable tax credits. For instance, if you have $2000 tax due and a $3000 refundable tax credit, you would receive a $1000 refund. 

The most popular refundable tax credit is probably the earned income tax credit (EITC). The EITC is a tax credit for low- to moderate-income workers who meet specific requirements regarding family size, filing status, and income.

2. Nonrefundable tax credits

A nonrefundable credit refers to a credit that can only be used to reduce your taxes maximum to $0. It can’t go any lower than that to create a negative tax liability, in which case you’ll get a refund. So, if you’re eligible for a $1000 nonrefundable tax credit, and the tax you owe is only $600—the $400 excess is nonrefundable. Some frequently claimed nonrefundable tax credits are lifetime learning credit (LLC), foreign tax credit (FTC), general business credit (GBC), etc. 

3. Partially refundable tax credits 

Partially refundable tax credits only reduce a certain amount of your taxes and leave the remaining nonrefundable. The American Opportunity credit, for example, is a partially refundable tax credit that allows you to pay up to 40% of the credit as a tax payment. If you calculate a $1,000 American Opportunity credit, you can claim up to $400 as a refundable tax credit and the rest as a nonrefundable credit.

Want to know more about finance? 

If you’d like to explore more entrepreneurship stories, get simple explanations of complex financial terms, or learn about the best productivity tools, find more posts like this on the Shoeboxed blog.


About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

IRS Offers Tax Credit Guidance to Businesses Hiring Unemployed Veterans and Youth

Businesses planning to claim the newly-expanded work opportunity tax credit (WOTC) for eligible unemployed veterans and unskilled younger workers hired during the first part of 2009 have until Aug. 17 to request the certification required for these workers, according to the Internal Revenue Service.

Newly-revised Form 8850, now available on IRS.gov, is used by employers to request certification from their state workforce agency. The American Recovery and Reinvestment Act, enacted in February, added unemployed veterans returning to civilian life and “disconnected youth” to the list of groups covered by the credit. Though eligible unemployed veterans and disconnected youth who begin work anytime during 2009 or 2010 may qualify a business for the credit, certification by the state workforce agency is required.

In general, an unemployed veteran is a person discharged or released from the military during the five years preceding the hiring date who received unemployment benefits for at least four weeks during the one-year period ending on the hiring date. A “disconnected youth” is a person age 16 to 24 on the hiring date who has not been regularly employed or attending school and who meets other requirements.

The WOTC offers tax savings to businesses that hire workers belonging to any of 12 targeted groups, including unemployed veterans and disconnected youth. The other 10 include people ages 18 to 39 living in designated communities in 43 states and the District of Columbia, Hurricane Katrina employees, recipients of various types of public assistance, and certain veterans, summer youth workers and ex-felons. The instructions for Form 8850 detail the requirements for each of these groups.

The certification requirement applies to all groups of workers except employees who were Hurricane Katrina victims. Normally, a business must file Form 8850 with the state workforce agency within 28 days after the eligible worker begins work. But under a special rule, businesses have until Aug. 17, 2009, to file this form for unemployed veterans and disconnected youth who begin work on or after Jan. 1, 2009 and before July 17, 2009. Notice 2009-28, posted today on IRS.gov, and the instructions for Form 8850 provide details on this special rule.