Tax Returns

5 Things You Should Know About Refundable Tax Credits

Updated for Tax Year 2015

OVERVIEW

There are two types of tax credits available for taxpayers: refundable and nonrefundable. Both types offer you the chance to lower the amount of taxes you owe, but refundable credits can also get you a tax refund when you don't owe any tax.

When filing their income taxes each year, taxpayers may have different goals in mind. Some may want to lower the amount of taxes they owe, seek the largest refund possible or avoid paying more in taxes than they are legally required to pay. Tax credits can help you meet all of those goals. There are two types of credits available for taxpayers: refundable and nonrefundable. Both types of credits offer you the chance to lower the amount of taxes you owe, but refundable tax credits can also get you a tax refund when you don’t owe any tax.

Refundable credits can provide you with a refund

Refundable tax credits are called “refundable” because they can reduce your tax liability below zero and allow you to receive a tax refund. If you qualify for a refundable credit and the amount of the credit is larger than the tax you owe, you will receive a refund for the difference.

Steven Williams, a private accountant and financial planner, explains, "A refundable credit is considered a payment of tax, similar to payroll withholding." This means that the amount of a refundable credit is subtracted from the amount of taxes owed, just like the amount of tax you had withheld from your paycheck. For example, if you owe $800 in taxes and qualify for a $1,000 refundable credit, you would receive a $200 refund.

With some of the larger refundable credits, like the Earned Income Tax Credit, the amount of your refund can be substantial. This makes refundable credits some of the most valuable parts of your tax return.

Even with zero tax liability, you may still qualify

With refundable credits, if you qualify, you can still use the credit even if you have...