Refundable Tax Credits

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A refundable tax credit is a type of tax credit that is treated as a payment. If the total of all payments (including any refundable tax credits) is more than a person's total tax liability, the Internal Revenue Service refunds the overpayment to the taxpayer.

By contrast, a nonrefundable tax credit can reduce a person's federal income tax liability to at most zero, and any remaining or unused tax credits are not refunded back to the taxpayer.

Difference Between Refundable and Nonrefundable Tax Credit

Here's one way to tell the difference between a refundable and a nonrefundable tax credit. Refundable tax credits show up in the Payments section of Form 1040. Nonrefundable tax credits, however, show up in the Tax and Credits section of Form 1040.

Refundable tax credits can be used strategically. Since they are treated as payments, these tax credits help offset certain types of taxes that normally cannot be reduced. For example, they can help offset the self-employment tax or the surtax on early distributions of retirement savings or other types of surtaxes such as the nanny tax, the net investment income tax or the additional medicare tax.

Refundable tax credits are strategic in another sense. These credits can produce tax refunds from the IRS larger than the amount of money that a personal actually paid through withholding and estimated tax.

This is particularly the case with refundable credits designed specifically for lower-income persons such as the earned income credit, the additional child tax credit, and the premium tax credit.

For the year 2015, the following tax credits were refundable.

  • Credit for federal income tax withheld. This is a refundable credit is in the strict sense of the word. It is a credit in the sense of a payment credited to your tax account at the IRS. And it is refundable in the sense that if you overpaid your tax, the IRS will refund you the overpayment.
  • Credit for estimated tax payments. Just like withholding, estimated tax payments are refundable credits in the strict sense.
  • Credit for extension payment. Just like withholding, extension payments are refundable credits in the strict sense.
  • the earned income credit. This is a tax credit for lower-income working persons. In some cases, the earned income credit can be large enough to generate a refund from the IRS larger than the amount of taxes actually paid in during the year.
  • the additional child tax credit. The child tax credit is divided into a nonrefundable portion and a refundable portion.
  • a portion of the American opportunity credit. Up to 40% of this tax credit is refundable, the remainder is nonrefundable.
  • the premium assistance tax credit. Under certain circumstances, a taxpayer with health insurance coverage purchased through a health insurance exchange may be eligible for subsidies from the IRS. Any subsidies not already paid out in advance by the IRS can be paid out as a refundable tax credit.
  • Credit for excess Social Security tax withheld. Another refundable credit in the strict sense. This refunds taxpayers who worked for two or more employers and whose total Social Security tax withholding exceed the maximum limit for the year.
  • Credit for excess Social Security withholding
  • Credit for federal tax on fuels. This tax credit is for people who paid excise tax on fuels but who used that fuel for nontaxable purposes such as farming, commercial fishing, or off-highway business use. See Form 4136 and Publication 510, Excise Taxes, for details.
  • Credits from Form 2439. This credit represents an investor's share of tax paid by a mutual fund or real estate investment trust on undistributed long-term capital gains. See the Instructions for Form 8949 and the Instructions for Form 1040 for details.
  • the health coverage tax credit. This tax credit had expired in 2013, but then in the middle of 2015, Congress passed a law to revive this program through 2019. The IRS has developed special procedures for eligible trade adjustment assistance recipients.