What is a Refundable Tax Credit?

October, 25 2024 by Veselina Arangelova, EA

When was the last time you visited your local library? Was it this past week or last month? Maybe you are one of the many who enjoy reading books just about anywhere (preferably from your Kindle), so you don’t know if your library card is even valid. I know my last visit was long ago – and forgoing the $5 renewal fee rendered the shiny blue plastic in my wallet useless.

Now you may wonder why I am asking you about the library, of all places. Many moons ago, when my card was still working, I was surprised to find a dozen booklets with bold letters on the cover that read “1040 Instructions” stacked on a tiny table next to the exit. To this day, these booklets are primarily found in libraries and other participating outlets during tax season and are very detailed. They are designed to help you prepare your taxes, walking you line by line through your return so you can understand what to write and where. Income, credits, deductions, worksheets, tips – you name it, it is there.

In my millennial mind, in a more connected world than ever, it is hard to imagine the need for printed instructions for anything, even my tax return. Not long ago, I ordered a custom shampoo formula, and inside the box was a tiny piece of paper with a QR code to scan in case I needed assistance. Maybe the IRS needs to consider this option?
 

Today, we have the benefit of technological innovation and digitization. Moreover, TurboTax and the ever-innovating team behind it make it possible to prepare a return from a mobile device. However, as I was preparing this blog, I realized how helpful it is to have a resource that answers all your questions—so here is the digital version of the IRS booklet if you are curious.

If you open the booklet, you’ll realize that your tax return is much more complicated than the blank, two-page Form 1040 you begin with. The truth is that most 1040s, as we affectionately refer to returns, sometimes consist of double or triple-digit pages when you account for all the forms that accompany the return. The more unique your tax life is, the bigger the return. You may be surprised to hear that a good chunk of that comes from the possible deductions and credits TurboTax so effortlessly helps us claim. And that’s why we’re here – to tell you more about one type of those credits you might be able to claim: the Refundable Tax Credits.

 

What is a Refundable Tax Credit?

Understanding the type of credits on your return is essential. Credits can either be refundable or non-refundable and are a type of tax benefit that can reduce the tax you owe to the government. Unlike non-refundable tax credits, which can only reduce your tax liability to zero, refundable tax credits can result in a refund if the credit amount is more than the taxes you owe. In other words, if you qualify for a refundable tax credit, you could get money back if you don’t owe any taxes.
 

Examples of Refundable Tax Credits

Some common examples of refundable tax credits include:

• Earned Income Tax Credit (EITC) – This credit is designed to help low- to moderate-income workers and families. The amount of the credit depends on your income and the number of children you have.
• Child Tax Credit (CTC) – This credit provides financial relief to parents or guardians with dependent children under 17 years of age. It is important to mention that it is a blend of non-refundable and refundable components. This means part or all the credit can offset any tax you owe and, if the liability is $0, you get the refundable portion to increase your refund.
• American Opportunity Tax Credit (AOTC) – This credit helps undergraduate students and their families pay for college expenses. Up to 40% of this credit is refundable.

Requirements to Qualify for Refundable Tax Credits

To qualify for refundable tax credits, you need to meet certain requirements. These requirements vary depending on the specific credit, but here are some general guidelines:
 

• Earned Income – Most refundable credits require you to have earned income, which includes wages, salaries, tips, and other forms of compensation.
• Filing Status – Your filing status (e.g., single, married filing jointly, head of household) can affect your eligibility for certain credits.
• Income Limits – Many refundable credits have income limits. You may not qualify for the credit if your income is too high.
• Dependent Children – Some credits, like the Child Tax Credit, require you to have dependent children who meet specific criteria (e.g., age, residency, relationship).

This isn’t a complete list of all requirements. If you believe you qualify for a credit, you can research the specific credit and the instructions for claiming it before completing your tax return so you don’t claim it in error.

As mentioned, individual tax returns can be complicated and very detailed. If your return has refundable credits, that isn’t always a reason for being audited, but it can be. While there isn’t a surefire way to avoid an audit, there are some steps you can take to reduce your chances or be prepared if it happens:
 

• Be Accurate – Double-check your numbers and correct any errors. Ensure you have all your tax forms before you begin your return, and don’t rush. Life is easier if you don’t have to file an amended return because you forgot to include a form that just arrived in the mail.
• Keep Records – Maintain organized records of your income, expenses and any documentation related to your tax credits.
• Follow the Rules – Make sure you understand the requirements for any credits you claim and follow them. If you claim a credit in error, you must pay it back if you are not eligible.

Remember, an audit is just a way of verifying the information on your return is correct. If you follow these simple steps, providing what is asked will not seem like such a monumental task, and there will be no reason to worry. If you have claimed credits on your return and are concerned about getting an audit, make sure to purchase a membership with us to have peace of mind. We are the experts when it comes to audits or notices and are happy to step in for you. Read more about our expert audit defense here.