What is a Refundable Tax Credit?
There are many tax credits available to U.S. taxpayers, depending on current tax laws that establish eligibility. Some tax credits are refundable, which means that even if they bring a person’s tax liability to less than zero, that money will be refunded. A refundable tax credit, therefore, can have the effect of returning more money to a taxpayer than he contributed into the tax system in a given tax year. Examples of refundable tax credits in the United States include the earned income tax credit and the additional child tax credit. All tax credits, like tax deductions, reduce the amount of taxes owed. Tax credits are considered to be more valuable in general than tax deductions, because they directly reduce the taxes owed, rather than reducing the amount of taxable income, which has a much more indirect and diluted effect. For example, a person who owes $10,000 U.S. Dollars (USD) in taxes, who claims a $1,000 USD tax credit, has a tax liability of $9,000 USD. However, a tax deductio
When I first came across the term “refundable tax credit,” I have to admit I was confused about its meaning. And now that the economic stimulus bill will be signed into law today, I’ve seen that my misconception is shared by others. A tax credit is a dollar amount that decreases the amount of tax you owe. Normally, a tax credit stops once you reach zero tax liability. However, a refundable tax credit can cause your tax liability to cross over zero, resulting in a refund. This is what is meant by “refundable.” Therefore, even if you owe no tax or had no income, a refundable tax credit might result in receiving a check from the government. In effect, there is a possibility that some people, due to refundable tax credits, may find themselves with an “negative effective income tax rate,” receiving more from the government than they put into the system. “Refundable” does not mean that you have to pay the credit back to the government over time. Depending on the tax credit, this may be the c
When tax professionals and the IRS talk about “refundable tax credits,” they do not mean that you have to pay the credit back to the government. A refundable tax credit means that if you owe less tax than the amount of the tax credit, you will receive a refund—even if you have no other tax liability for 2008. That’s not a bad deal. In other words, if you owe $200 to the government before claiming the credit, and you qualify for $8,000 for the first-time home buyer credit, rather than paying the government, you will receive a check for $7,800. Even if you had no income in 2008, owed no tax, and purchased a qualifying house in 2009, the government will send you a check for $8,000. What if I bought the house last year? If you purchased a house in 2008 and were a first-time buyer, you qualify for the older refundable tax credit with a maximum of $7,500. This does require that you pay the $7,500 tax credit back over the course of fifteen years, starting two years after the date of the purch
