Are Tax Credits Refundable?

Man holding pencil, writing on paper. Are tax credits refundable? Runey & Associates Wealth Management.

When you file your taxes, you’ll likely stumble upon tax credits and deductions that you may qualify for. These adjustments to your tax liability can result in a significant decrease in the amount you owe for the year. In some cases, you may receive a refund, even if your tax liability was nil. 

It helps to understand the difference between non-refundable and refundable tax credits. Non-refundable tax credits reduce your tax liability, but they will not result in a refund. Therefore, even if they reduce your tax liability to zero, the balance of the credit will not be refunded to you. 

On the other hand, refundable tax credits can reduce your tax liability to zero, and any amount remaining will be refunded to you by the IRS. Refundable tax credits are set up to give relief to those with low incomes or who are raising young children on middle-range incomes. 

What Tax Credits Are Refundable?

There are four main tax credits that are classified as refundable. These include:

Earned Income Tax Credit

Perhaps one of the most recognized of the refundable tax credits, the earned income tax credit (EITC) is designed for low- and middle-income families. Individuals with no children may also qualify for this credit, but the adjusted gross income (AGI) of the individual must be very low. 

To qualify for the credit, single taxpayers with no children must have an AGI of $16,480 or less, while married filing jointly filers must have an AGI of $22,610 or less. The maximum EITC for those with no children is $560.

For 2022, single or head of household filers are allowed an AGI of $53,057 if they have three or more children, while married filing jointly individuals must have an AGI of $59,187 or below if they have three or more children. In these cases, the maximum EITC is $6,935. 

The EITC is fully refundable, which allows the amount of the credit to be paid out to you if the amount exceeds the tax liability that you owe for the year. You must have a valid Social Security number, not claim the foreign income exclusion credit, and have investment income of less than $10,000 to qualify. 

Health Coverage Tax Credit

The Health Coverage Tax Credit is a refundable tax credit that pays up to 72.5% of qualified health premiums for eligible individuals and their families. To qualify for the credit, you’ll need to purchase your health coverage plan from your state’s Health Care Marketplace and meet certain income requirements. 

For 2022, your annual income must be 400% or less of the federal poverty line according to the size of your family and filing status. 

You can apply the credit throughout the year towards your monthly health plan payments, or you may receive a credit at the end of the year in the form of a refundable tax credit. The amount of the credit will vary depending on the plan you choose. 

Child Tax Credit

If you have children, you may qualify for the child tax credit if you meet certain income requirements. The current child tax credit allows for $2,000 per dependent who is 17 years of age or younger. 

Single and head of household taxpayers must have an income threshold of $200,000 or less, while married filing jointly are given a threshold of $400,000 or less. 

The child tax credit is partially refundable, which means that 70% of the credit may be refunded to you if your tax bill falls below the credit amount. 

President Biden has proposed changes to the tax code, allowing for increased child tax credits of $3,600 for children younger than five and $3,000 for children between the ages of five and seventeen. These modifications would also make the credit fully refundable. However, they have not yet been approved by Congress.

American Opportunity Credit

The American Opportunity Credit is available for qualified education expenses such as college tuition, books, and other supplies for class. The maximum amount of the credit is $2,500, and it can only be used in the student’s first four years of higher education. 

You’ll need to meet certain income limits to qualify. For 2022, the maximum amount that you can earn is $180,000 for joint filers and $90,000 for everyone else. 

The credit begins to be reduced at income levels of $80,000 for single filers and $160,000 for joint filers. If the tax credit reduces your tax liability below $0, you can receive a refund equal to up to 40% of the credit, or $1,000.

How Should I Use My Tax Refund?

If you qualify for any of the refundable tax credits and receive a refund from the IRS, you may use it for any purpose. However, financially savvy individuals recognize that refunds can be quite helpful for paying off outstanding debt or investing towards their retirement

You can even use it to pay a little extra towards your mortgage, thus reducing the overall interest you’ll pay to your lender. However you choose to use your tax refund, make sure that it’s for something that benefits you, or may benefit you in the future. 

Using a refund for frivolous purposes, such as a vacation or to buy fancy new clothes, may feel good now, but you’ll wish you had used it in other ways in the future, especially if you struggle financially from month to month.