Q: What’s the difference between a refundable and nonrefundable tax credit, and why does it matter?
A: Both can reduce the taxes you owe, but a refundable credit can go one important step further and potentially give you money back even after your tax has been reduced to zero.
For a simple way to see the difference, suppose you owe $600 in federal income tax and qualify for a $1,000 tax credit. With a nonrefundable credit, the credit can generally reduce your $600 tax to zero, but you generally don’t get the unused $400 as a refund.
With a fully refundable $1,000 credit, the credit can reduce your $600 tax to zero and the remaining $400 can be paid to you as a refund.
The Earned Income Tax Credit is an important example. This refundable federal credit is designed primarily for low- and moderate-income workers and families. You must have a certain amount of earned income to qualify; eligibility and the amount of the credit depend on factors including filing status and number of qualifying children.
Some credits can also be partially refundable. The Child Tax Credit, for example, has a refundable portion known as the Additional Child Tax Credit. This means that, depending on your circumstances, part of the credit may be given back even if you don’t owe enough tax to use the entire credit.
The bottom line: You may benefit from filing a tax return even if your income is low enough that you aren’t otherwise required to file. If you qualify for a refundable tax credit, filing a return could result in money being refunded to you even when you owe little or no federal income tax.
Send questions about your taxes to Vincent Hicks, a CPA based in Cambridge who has more than 20 years of experience, at vincent@hickscpasolutions.com. You can call Hicks at (859) 553-0788.
