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Updated on Monday, March 22, 2021
Claiming the tax credits you’re eligible for can help you maximize the amount of money you receive back from the IRS, and refundable tax credits can be even more valuable. A refundable tax credit is a tax credit that allows you to get a tax refund when you don’t owe any taxes or the credit eliminates what you owe.
In this article, we cover what you need to know about refundable tax credits, from some of the most common refundable tax credits to how to claim them.
- What is a refundable tax credit, and how does it work?
- Common examples of refundable tax credits
- How to claim a refundable tax credit
What is a refundable tax credit, and how does it work?
Tax credits reduce how much you owe when you file your federal and state tax returns. They are designed to encourage or reward certain behaviors that help the economy, such as going to college or making your home more energy efficient. Additionally, most parents are eligible to claim some sort of tax credit.
By claiming applicable tax credits, you can lower your tax bill or get a larger tax refund. There are two main forms of tax credits: refundable and nonrefundable. With a refundable tax credit, if the credit is larger than the amount you owe, you can get some or all of the remainder paid as a refund.
Refundable tax credit vs. nonrefundable tax credit
While a refundable credit allows you to get some or all of any excess amount as a refund, with nonrefundable credits, the excess amount is forfeited.
As an example, let’s say you completed your tax return and owed $200 to the IRS. If you qualified for the American opportunity tax credit (AOTC), which applies to people pursuing a college degree, you could get a credit of up to $2,500. If you qualified for the full amount, the AOTC would cover your tax bill, leaving $2,300 left over. The AOTC is a refundable tax credit, giving you up to 40% of the remaining credit refunded to you. In this case, that means you’d get $920 as a tax refund — 40% of $2,300.
By contrast, say you claimed the Lifetime Learning Credit (LLC) instead, which applies to people taking classes for professional development. You can get a credit of up to $2,000 with the LLC, but it’s a nonrefundable tax credit. After satisfying your tax bill, you don’t get the remainder back. By claiming the LLC, you wouldn’t owe any money to the IRS — but you wouldn’t get a tax refund, either.
Tax credit vs. tax deduction
Tax credits and tax deductions are frequently misunderstood. While they have similar features and can help you save money on taxes, the key difference between a tax credit and tax deduction is how they function. A tax credit reduces what you owe to the IRS, while a tax deduction reduces your taxable income.
One common example is the student loan interest deduction for those with outstanding education debt. If you paid interest toward your student loans during the tax year, you can deduct $2,500 or the amount of interest you actually paid, whichever is less.
Common examples of refundable tax credits
Here are four of the most common refundable tax credits:
Child tax credit
Under the child tax credit, you can get a credit for each child you have under the age of 17. If you owe no taxes, the child tax credit is refundable, giving you a larger tax refund after your return is processed.
Who qualifies: Families with children under the age of 17 that have a valid Social Security number. The credit begins to phase out at $200,000 of income, or $400,000 for couples filing jointly.
How much it’s worth: $2,000 per child (up to $1,400 is refundable).
[Important: The American Rescue Plan Act, passed in March 2021 as part of COVID-19 relief efforts, expanded the child tax credit. Under the American Rescue Plan, households with children can claim up to $3,600 per child under the age of six, and up to $3,000 for each child ages six and older, regardless of income.]
Earned income tax credit
Low- to moderate-income workers may qualify for the earned income tax credit (EITC). If you have children or dependents, the amount of your credit can increase. The average amount received through the EITC is $2,461.
Who qualifies: To qualify for EITC, you must have earned income during the tax year, have a valid Social Security number, and have less than $3,650 in investment income for the year you claim the credit.
How much it’s worth: Eligible families can receive up to $6,660, while individuals can get up to $538 for the 2020 tax year.
Premium tax credit
The premium tax credit is designed to help low- and moderate-income families afford health insurance. With the credit, eligible families can get a credit to offset their insurance premiums. It is refundable, so if your plan costs less than the credit, you can get a larger tax refund.
Who qualifies: To qualify, your income must be 100% to 400% of the federal poverty line for your family size. You cannot file a married filing separately tax return, and you must enroll in coverage through the Health Insurance Marketplace.
How much it’s worth: The amount of the credit is equal to the premium for the second-lowest silver plan (considered the benchmark) available through the Marketplace for your family. As of 2020, the average monthly premium for the second-lowest silver plan for a 40-year-old individual was $452.
American opportunity tax credit
Students attending college to get a degree or another professional credential may qualify for the American opportunity tax credit (AOTC). If eligible, students can get a credit for what they paid toward qualified education expenses.
Who qualifies: To qualify for AOTC, students must be in the first four years of their college education and enrolled at least half-time. To get the full credit, your income must be $80,000 or less ($160,000 or less if married filing jointly).
How much it’s worth: The AOTC is worth up to $2,500. If the credit brings the amount you owe to zero, up to 40% of the credit will be refunded to you.
How to claim a refundable tax credit
Tax credits and deductions can change from year to year depending on when certain bills expire and new tax regulations are passed. It’s a good idea to visit the IRS website for a current list of possible tax credits and deductions and the necessary forms to claim them on your taxes.
Keep in mind that you don’t qualify for credits automatically; you have to fill out the corresponding form for each credit and submit it with your tax return to be eligible. If you need help preparing your taxes or identifying what nonrefundable and refundable tax credits you’re eligible for, consult a tax professional.
If you earn $57,000 or less, you can qualify for free tax preparation assistance through the IRS’s Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs. To find a location near you, use the VITA/TCE locator tool.