Refundable tax credits vs nonrefundable tax credits

One is limited to the amount of tax you owe, and the other pays you no matter how much you owe.

Derek Silva

Derek Silva

Published May 7, 2020

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KEY TAKEAWAYS

  • Tax credits reduce your tax liability — the amount of income tax you owe for the year

  • A refundable credit is paid to you even if you have no tax liability, but a nonrefundable credit only pays out in full if you actually owe income tax

  • Many tax credits are targeted at low-income individuals and families

  • Even if don’t need to file a federal tax return, you may want to so you can claim some refundable tax credits

Tax credits are valuable tax breaks that reduce your tax bill dollar-for-dollar. If you owe $4,000 of federal income tax and qualify for $4,000 of tax credits, you no longer owe any income tax. There are two types of tax credits. A refundable tax credit will pay you a full or partial refund even if your tax liability — the amount of annual income tax you owe — is zero. The amount you get from a nonrefundable tax credit is limited to your tax liability. There are more nonrefundable credits available than refundable credits.

Each tax credit has its own eligibility requirements — often based on your adjusted gross income — but most credits benefit families, lower-income taxpayers, and those who otherwise would have a difficult time affording necessary expenses like health insurance premiums.

In addition to federal credits, states with their own income tax may have state-specific tax credits. These are especially common for low-income and older taxpayers who rent or pay property taxes.

For more help finding tax credits you qualify for, try our complete guide to federal tax returns.

In this article:

What are tax credits?

Tax credits reduce your tax liability, which means they directly lower the amount of income tax you owe for the year. If you owe $6,000 in taxes for 2020 but you qualify for $2,000 in tax credits, you will only owe $4,000 in taxes for the year.

Each tax credit has its own eligibility requirements, based on your income, spending, or how many dependents you have. Many tax credits are targeted at families and low-income tax filers.

There are two types of tax credits:

  • Refundable tax credits result in a refund even if you don’t actually owe income tax for the year
  • Nonrefundable tax credits won’t result in a refund if your tax liability is zero

When talking about tax credits, it’s important to distinguish between the refundable portion of a credit, and your overall tax refund. The refund from a tax credit is the amount you get from that credit. Your overall refund — which is the actual payment you get from the IRS after filing your taxes — is the amount by which you overpaid your taxes throughout the year, plus the refunds you got from individual credits.

As an example, let’s say you paid $2,000 of income tax throughout the year but your tax liability was $0. You would get a tax refund of $2,000. If you also qualify for a refundable credit worth $500, then your overall tax refund will be $2,500.

Related article: 50 credits and deductions for 2020 taxes

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Tax credits vs tax deductions

Credits and deductions both decrease your income tax bill, but they do so in different ways. A tax deduction reduces your taxable income. If you made $75,000 and take $15,000 of deductions, only $60,000 of your income is used to calculate how much tax you owe. This will result in owing less tax, but the effect is indirect. Tax credits directly decrease how much tax you owe, so they are generally seen as more valuable than deductions. That’s one reason credits are often available to lower-income tax filers and those who cannot otherwise afford certain types of payments. However, many tax filers will qualify to take some credits and some deductions on their tax return.

Read our full breakdown of tax credits vs deductions.

Refundable tax credits

A refundable tax credit will pay you a refund if the amount of credit you qualify for is greater than the amount of income tax you actually owed for the year. More technically, refundable credits pay a refund if they bring your tax liability below zero.

Not all refundable credits are fully refundable, so you may only qualify to get a refund up to a certain value. As an example, let’s say your tax liability was $1,000 and you qualified for a tax credit worth $1,500. If the credit is fully refundable, you will get a $500 refund (the credit pays off the first $1,000 in tax liability and you get the rest). However, let’s say the credit is only partially refundable, up to $300. You will get a refund of $300, even though it means you aren’t getting the full value of the credit you qualified for.

Here are five refundable tax credits you may qualify for:

  • Earned income tax credit (EITC)
  • Premium tax credit (PTC)
  • American opportunity tax credit (AOTC)
  • Additional child tax credit (ACTC)
  • Health coverage tax credit (HCTC)

Earned income tax credit (EITC)

The EITC primarily benefits low-income taxpayers, but the income requirements and credit amounts depend on how many children you have. For 2020 taxes, the EITC is worth up to $538 for people with no children and up to $6,660 for people with three or more children. The EITC is fully refundable and individuals who wouldn’t normally have to file a tax return may still want to file a return just to claim the EITC.

Read more about how to claim the earned income tax credit.

Premium tax credit (PTC)

If you get a health insurance plan through the Obamacare marketplace and your household income is between 100% and 400% of the federal poverty line, the PTC will reimburse the amount you spent on monthly premiums. The PTC is fully refundable. You can also receive it in advance — each month instead of just when you file your return — by taking the advance premium tax credit (APTC).

American opportunity tax credit (AOTC)

The AOTC is available for taxpayers with certain education expenses — tuition, books and classroom supplies. The credit is worth up to $2,500 per student and if it brings your liability below $0, you can get a refund for 40% of the remaining credit amount, with a maximum refund of $1,000. See if you qualify for the AOTC.

Additional child tax credit (ACTC)

If you took the child tax credit (nonrefundable) and your credit amount was greater than your tax liability, you can claim the ACTC in order to get a refund. The ACTC can result in a refund worth up to $1,400 per child.

Health coverage tax credit (HCTC)

The HCTC covers 72.5% of your health insurance premiums, including COBRA coverage, if you meet either of these criteria:

  • You’re between the ages of 55 and 64, and you have a pension that was taken over by the Pension Benefit Guaranty Corporation (PBGC).
  • You receive benefits through Trade Adjustment Assistance (TAA), Alternative Trade Adjustment Assistance (ATAA), or Reemployment Trade Adjustment Assistance (RTAA). You may qualify for these programs if you lost your job due to changes in international trade, but you will need to petition the Department of Labor so it can certify you as eligible.

Nonrefundable tax credits

A nonrefundable tax credit can only be worth as much as your tax liability. For example, if you owed $1,200 of tax for the year and qualified for a nonrefundable tax credit worth $1,600, only $1,200 of the credit would apply to your tax return.

Most federal tax credits are nonrefundable, but some of them do allow you to carry over any unused credit onto next year’s tax return.

Here are 10 common nonrefundable credits:

  • Child tax credit (CTC)
  • Credit for other dependents (ODC)
  • Adoption credit
  • Lifetime learning credit (LLC)
  • Saver’s credit
  • Child and dependent care tax credit
  • Foreign tax credit
  • Credit for the elderly or the disabled
  • Energy tax credits
  • Credit for electric plug-in vehicles

Child tax credit (CTC)

Most parents qualify for the child tax credit. It’s worth up to $2,000 per eligible child you have, and you can qualify if your income is less than $400,000 if you’re married filing jointly or $200,000 for all other filing statuses. (You must have earned income of at least $2,500 to qualify.) The CTC is not refundable but if you would have qualified for a refund, you can claim the additional child tax credit, which is refundable.

Learn more about the child tax credit.

Credit for other dependents (ODC)

The ODC is available if you have dependents who wouldn’t qualify for the CTC, such as a parent or sibling you care for. It’s worth up to $500 per dependent and you can claim it using the same tax forms as the CTC.

Adoption credit

The adoption credit is worth up to $14,080 per child, based on the adoption costs you incurred. It’s not refundable but any amount you can’t claim on this year’s return can be carried over for up to five years.

Lifetime learning credit (LLC)

The LLC is worth up to $2,000 per tax return for educational expenses. Eligible expenses can include undergraduate courses, graduate courses, professional degree courses, and classes you take for learning or improving job skills. See who should claim the lifetime learning credit.

Retirement savings contributions credit (saver's credit)

The saver’s credit is worth up to 50% of your contributions to an IRA, employer-sponsored retirement plan, or ABLE account. The maximum credit is $4,000 for joint tax filers and $2,000 for all others. To claim the saver’s credit in 2020, your income must be $65,000 or less if you’re a joint filer and $32,500 or less if you’re a single filer.

Child and dependent care tax credit

If you had to pay for child care (or for someone to care for a nonchild dependent) so you could work or look for work, the dependent care credit can reimburse your expenses. The maximum credit is $3,000 if you had one dependent and $6,000 if you had more than one dependent.

Related article: How the coronavirus will impact your taxes

Foreign tax credit

The foreign tax credit reimburses you if you already paid tax on income from another country. In addition to income from working in another country or territory, you may qualify for the foreign tax credit if you paid taxes on interest and investment income from a foreign source. Check your 1099-DIV, 1099-INT, and Schedule K-1s to see if you have foreign income. (Learn about what’s on your 1099 forms.)

Credit for the elderly or the disabled

The credit is available to individuals who are at least 65 years old or who are under 65 and receive disability benefits. The income limit depends on your filing status, but it ranges from $12,500 to $25,000.

Energy tax credits

There are two main renewable energy tax credits an individual may qualify for. If you installed certain types of renewable energy in your home, you may be able to get a credit worth up to 10% of the cost by claiming the residential renewable energy tax credit. General improvements you make to your home in order to increase its overall energy efficiency may qualify you for the nonbusiness energy property credit.

Interested in living sustainably? Here are the best and worst states for green homes.

Credit for electric plug-in vehicles

Taxpayers with a plug-in electric vehicle may qualify for a tax credit worth up to $7,500. A vehicle may qualify whether it was for personal or business use.

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Personal Finance Expert

Derek Silva

Personal Finance Expert

Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.

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