Refundable and Non-Refundable Tax Credits

In order to understand the difference between refundable and non-refundable tax credits, you must first understand what exactly a tax credit is.  A tax credit reduces the amount of tax you must pay, so if you owe $3,000 and receive a $1,000 tax credit, you now only owe $2,000 in taxes.  Here’s where the difference between these two types of tax credits becomes significant.  Once a refundable tax credit brings your total tax liability to zero, you will receive a refund of the additional amount that is left over.  For example, If you must pay $3,000 in taxes and you receive a $3,500 refundable tax credit, not only will you not owe any taxes, but you will receive that extra $500 back from the government.  A non-refundable tax credit can only bring your tax liability to zero.  If you must pay $3,000 in taxes and you receive a $3,500 non-refundable tax credit, you will not owe anything, but you will not receive the leftover amount back.  So the non-refundable credit only counts towards taxes that you already owe.

So which tax credits are refundable and which are non-refundable?  Perhaps the most well-known refundable tax credit is the Earned Income Tax Credit.  To see if you qualify for this credit, see the IRS information page for the EITC:  Other refundable tax credits include the Additional Child Tax Credit and the Health Coverage Tax Credit.  Most tax credits are non-refundable, including the Alternative Motor Vehicle Credit, the Foreign Tax Credit, and the Retirement Savings Contributions Credit.

Overall, the most important thing to remember is that a non-refundable credit can only bring your tax liability to zero.  A refundable credit can bring your tax liability to zero, but can cause you to get a refund of the additional left over after you hit zero.

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