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What Are Refundable Tax Credits vs. Non-Refundable Tax Credits?

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Last year, I wrote about the difference between a tax credit and a tax deduction. Like marginal tax rates, it’s a tax topic that is often misunderstood because, well, our tax code is confusing!

Today, I want to talk about refundable tax credits vs. non-refundable tax credits, because it’s been in the news a lot lately after the big stimulus bill was passed. If you’re unsure what the difference is between a tax credit and a tax deduction, I invite you to review my article from 2008.

A tax credit can be refundable or non-refundable.

To better explain the difference, I’ll have to start with an example:

  • Let’s say you owe $500 in taxes before looking at any of your tax credits. Boo!
  • You find that you are entitled to a tax credit of $1,000. Yay!
    • If the tax credit is refundable, then the government would send you a $500 check. You owe $500, you have a refundable $1000 credit, so you are entitled to the difference.
    • If the tax credit non-refundable, then you get nothing. You owe $500, you have a non-refundable $1000 credit, but since it’s non-refundable, you don’t get the difference.

That’s why refundable tax credits are so awesome… unfortunately, there aren’t very many refundable tax credits. In fact, as of this writing there are only five – the Additional Child Tax Credit, the Earned Income Credit, the Excess Social Security and RRTA Tax Withheld Credit, the First-time Homebuyer credit, and the Health Coverage Tax Credit. Every other credit is non-refundable.

It was a hot topic during the 2008 Presidential campaign as the party nominees battled each other over how socialist each candidates’ tax plans were. One of the most interesting statistics I learned from that period was that an estimated 37.8% of tax filers in 2009 would pay zero or negative tax!

Amazing huh?

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12 Responses to “What Are Refundable Tax Credits vs. Non-Refundable Tax Credits?”

  1. Richard says:

    Hmmm… good article! Question though… when you talk about owing, do you mean your liability for the year, or how much you still actually owe?

    For example, what if after I do my taxes, my total tax liability is $1,500. But I’ve already paid exactly $1,500 in taxes straight from my salary. I recheck my 1040 and realize that I have a $500 non-refundable tax credit in there. So my total tax liability is actually $1,000. But I’ve already paid the Man $1,500. Do I get back the $500 in this case? Or is it that because I paid the $1,500, I can’t because that credit is “non-refundable”?

  2. “I learned from that period was that an estimated 37.8% of tax filers in 2009 would pay zero or negative tax!”

    I wonder how many of these people are students with minimal earnings? Certainly that doesn’t account for all of them, but it would be a chunk. A 15 year old kid with a paper route isn’t a drain on society simple because he doesn’t pay income tax.

  3. JW-

    Refundable credits encourage tax fraud.

    The Earned Income Tax Credit, because of its “refundable” nature, is probably the largest source of tax fraud. About 25% to 30% of all EITC claims are fraudulent.

    Refundable credits, such as the EITC, are in reality welfare. If the government wants to provide welfare benefits to low income individuals and families, which is fine, it should do so separately and not use the tax return as the method of delivery.

    Tax preparers have enough trouble with just getting the proper information from clients for legitimate tax items. They should not also be responsible for determining if a person is eligible for welfare.

    TWTP

  4. Posco says:

    I was just going to say what Flach said above… EIC is basically a euphemism for welfare.

    For some reason it seems less humiliating to receive EIC than it is to be participating in a welfare program.

    And… I know how tempting it is to cook numbers to receive the EIC. A couple years ago I disqualified my family from EIC due to some stock transactions that made my investment income too high.

  5. eric says:

    Oh refundable tax credit….how I love thee.

  6. Mat says:

    Will you discuss non refundable tax credits too? I want to make sure I’m not missing out on anything :)

  7. Donna says:

    At least you have to actually work to get the Earned Income Tax Credit – hence it being called the “Earned” Income Tax Credit – I don’t quite consider that welfare.

    I used this when I was a single mom and it helped me buy a house for us (back before there was all this other house buying credits). I thought welfare was for those who didn’t work.

  8. Donna says:

    Also the Earned Income Tax Credit was implemented to offset the Social Security taxes that were taken out of your (my) paycheck. Now the one thing I don’t quite understand is if in taking that credit should I still get credit for that time as earned toward Social Security? I can see not but I believe it does still show up. In my case that really isn’t going to matter because I ended up getting married and quitting work so if I ever draw myself it will be on my husband’s income but I do wonder about that for those that don’t.

  9. Joe says:

    the Refundable American Opportunity Credit is one that the article left out. It’s for education expenses.

    IRS form 8863


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