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Updated for Tax Year 2021 • October 16, 2021 04:10 AM 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. For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post. 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.
Refundable credits can provide you with a refundRefundable tax credits are called “refundable” because 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.
Even with zero tax liability, you may still qualifySome taxpayers may find that nonrefundable credits, deductions or other circumstances leave them with zero taxes due. Even with no taxes owed, taxpayers can still apply any refundable credits they qualify for and receive the amount of the credit or credits as a refund.
Each credit has different qualificationsAll tax credits come with a set of qualifications that the taxpayer needs to meet in order to receive the credit. Some common requirements include:
While some credits are specifically for lower-income taxpayers, others have much higher income thresholds. Many of the credits even have a step scale in which taxpayers with lower incomes are eligible for a larger credit than taxpayers at the higher end of the income scale. Available credits change from year to yearWhether or not a tax credit is available every year is not guaranteed. Each year, Congress has the opportunity to extend many of the tax credits available the previous year.
Congress can change the rulesWhen deciding whether to extend a tax credit or allow it to expire, the federal government sometimes compromises by altering the terms of the credit, making it worth more or less than it had been in previous years. For example, the First-Time Homebuyer Credit created in 2008 was originally worth up to $7,500 with the requirement that the taxpayer repay a portion of it each year. Instead of allowing it to expire at the end of 2008,
The federal government can also alter the terms of the credit. For example,
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The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business. How do refundable credits work?Refundable tax credits are called “refundable” because 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. For example, if you owe $800 in taxes and qualify for a $1,000 refundable credit, you would receive a $200 refund.
What does it mean to make a tax credit fully refundable?REFUNDABLE VERSUS NONREFUNDABLE TAX CREDITS
The maximum value of a nonrefundable tax credit is capped at a taxpayer's tax liability. In contrast, taxpayers receive the full value of their refundable tax credits. The amount of a refundable tax credit that exceeds tax liability is refunded to taxpayers.
Do refundable tax credits reduce taxable income?A refundable tax credit not only reduces the federal tax you owe but also could result in a refund if it more than you owe. Let's say you are eligible to take a $1,000 Child Tax Credit but only owe $200 in taxes. The additional amount ($800) is treated as a refund to which you are entitled.
What does it mean for a tax credit to be refundable vs non refundable?Both refundable and nonrefundable tax credits lower your tax bill dollar for dollar. Nonrefundable credits only apply to your tax liability, while refundable tax credits can wipe out your tax bill and provide a refund for the remaining credit.
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