Refundable Credits 101

The term “refundable credit” doesn’t mean you can “take it back” like you would at a store (as in “my great aunt has bought me the same sweater every Christmas and now I just take it back for a refund”).

A refundable credit is a tax break that could both cover your tax liability and add extra money to your tax refund (if you qualify for a refund, of course). How does that work? Well, let’s take a look.

How tax refunds are calculated

When you get a check for your tax refund, the government is paying you back any money you paid in excess on taxes during the last year. If you paid $5,000 in taxes but only owed $4,800, you’ll get a $200 refund once you file your tax return for the year.

Since a refund is basically your “change” for the year, you usually don’t get more money than the excess you paid Uncle Sam. With refundable credits, though, that “usually” takes a back seat.

Adding money to your refund

A regular, or non-refundable, tax credit directly reduces your tax obligation: If you owe $800 in taxes and have a $900 credit, then the credit takes care of the entire $800 you owe. A refundable credit for $900, on the other hand, will cover the $800 and add the leftover $100 to your tax refund if you qualify.

The best part of a refundable credit is that you don’t have to owe taxes to use it. You’d just have that $900 added to your refund amount, provided you qualify for the full refundable credit.

Common refundable credits

The Earned Income Tax Credit (EIC) is one of the most well-known refundable credits. It’s designed to help lower-income, working taxpayers, with or without dependents, and you could receive the entire credit amount as a refund if you don’t owe any taxes when you file your return.

The American Opportunity Tax Credit is a go-to refundable credit for college students in their first four years of undergrad. The whole credit is worth $2,500, and it’s refundable up to $1,000.

The Additional Child Tax Credit is a refundable tax credit for taxpayers with children. If you can’t use the full Child Tax Credit due to your AGI, the Additional Child Tax Credit may help you snag more of the credit amount.

If you have any more questions about refundable tax credits and how they work, fire away in the comments below!