What Are Refundable Tax Credits?

You probably know that tax credits help you save money on your taxes, but you may not understand how this works or who qualifies for them.

All tax credits have unique eligibility requirements, and some are worth more than others. Tax credits also come in two types: refundable and nonrefundable. While both are nice, refundable tax credits offer the better deal because they can reduce your tax liability below zero, so you could get a refund even if you don’t owe any taxes.

You can learn more about refundable tax credits in detail below, along with some common ones you may qualify for.

What’s A Tax Credit?

Tax credits are not to be confused with tax deductions, which also help to reduce your tax liability. A deduction reduces your taxable income — that is, the amount of money subject to income tax. So if you earned $50,000 last year and qualified for $15,000 in deductions, you’d only pay taxes on the remaining $35,000.

Tax credits, on the other hand, directly reduce your tax bill. So if you owe $5,000 in taxes for the year, but you receive $2,000 in credits, you’ll only pay $3,000 in taxes. The government will refund you any excess it took from your paychecks throughout the year.

What’s A Refundable Tax Credit?

Most tax credits are nonrefundable. This means that they can reduce your tax bill to zero, but the government won’t credit you for any extra credits. Refundable tax credits can reduce your tax bill below zero. If your total refundable tax credits exceed your tax liability, the government will pay you the difference. Say your tax bill is $5,000 for the year and you qualify for $6,000 in refundable tax credits. The government will now give you back all the income tax it took from your paychecks, plus an extra $1,000.

This means that you can get a tax refund even if you don’t owe any taxes or aren’t required to file a tax return for the year. But you must file a return in order to claim any refundable tax credits you qualify for. Refundable tax credits are calculated after your tax deductions and nonrefundable credits to ensure you get the largest return possible.

Common Refundable Tax Credits

Below are three of the best-known refundable tax credits that you may qualify for.

Earned Income Tax Credit (EITC)

Perhaps the best-known refundable tax credit is the Earned Income Tax Credit (EITC). It’s aimed at low-income families, especially those with dependent children. In order to qualify, you must have earned income for the year and have no more than $3,500 in investment income. You must also file taxes as single, head of household, qualifying widow(er), or married filing jointly. Married couples filing separately cannot claim this credit. Your earned income and your adjusted gross income (AGI) — your income minus tax deductions — must be below the following thresholds for the 2018 tax year:

Filing Status No Qualifying Children 1 Qualifying Child 2 Qualifying Children 3+ Qualifying Children
Single, head of household, or qualifying widow(er) $15,270 $40,320 $45,802 $49,194
Married filing jointly $20,950 $46,010 $51,492 $54,884