Refundable Tax Credit

Publication Date :

29 May, 2025

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Table of Contents

Refundable Tax Credit Meaning

A refundable tax credit refers to a credit one can get refunded even if one does not have to pay any tax to the government in the financial year. It serves to provide welfare benefits to lower & middle-income groups, and it is implemented by the Internal Revenue Service (IRS).

It helps a taxpayer reduce their tax liability to zero and may also give them a cash refund from the IRS if the tax credit exceeds that of tax obligation. It encourages people to file taxes even if they don't have to because many have yet to receive refundable credits due to non-filing of taxes.

Key Takeaways

A refundable tax credit offers refunds to lower and middle-income groups, benefiting them even without tax liability as per IRS implementation.
It is applicable to low-middle-income households and people eligible for child tax care and earned income tax credit.
It benefits by boosting low-income workers' income, providing financial stability, establishing fairer tax regimes, increasing disposable income, stimulating economic activity, and reducing tax liability for low-income individuals.
It lowers tax liability to zero, whereas non-refundable credit only reduces tax liability to zero.

Refundable Tax Credit Explained

A refundable tax credit is a particular category of tax credit that allows a refund to the taxpayer when their tax liability becomes zero in situations where the amount of credit value exceeds that of their total tax obligations, transforming the excess amount as a refund—the tax credits function by initially reducing the tax bill obligation of a taxpayer dollar for dollar. Further, when the taxpayer claims such refunds, then they remove the credit amount from their gross tax liability until all their tax offsets. Therefore, if the IRS finds that the credit exceeds the tax obligations, then it gives a cash refund to the taxpayer.

In the USA, their structure helps in giving social benefits to low- & moderate-income families. They also promote the buying of health insurance and investment in retirement plans amongst people. On meeting specific fixed criteria of family size and income, one can be eligible for such refunds.

Hence, such families can get financial relief, achieve financial stability, and reduce their poverty. Consequently, the disposable income of low-income families increases, leading to increased purchasing power, greater demands, and stimulating the economy. Nevertheless, the process of tax filing remains challenging and complex for poor taxpayers to navigate, discouraging them from filing taxes to claim refunds. Also, it can lead to fraud from antisocial elements and higher administrative costs. Recently, the IRS has launched its Interactive Tax Assistant (ITA) to help with tax filing.

Who And What Qualifies?

The IRS has established specific guidelines to qualify for refundable tax credits such as the Earned Income Tax Credit (EITC):

Investment Income: To qualify, investment income must be $11,000 or less.
Income Levels: The income limits vary based on filing status and the number of children:
- For single filers without children, the income limit is $17,640.
- For married couples filing jointly with more than three children, the income limit is $63,398.
Family Size: Larger families with incomes below the specified limits are more likely to qualify.
Factors Affecting Qualification: Self-employment tax, child care costs, taxes on early retirement account distributions, and self-employment income can all affect qualification.
Eligibility Criteria: Eligibility depends on various factors, including income level, type of income (earned vs. investment), savings, investment type, and occupation.
Credit Amount: Generally, taxpayers with lower incomes receive more extensive credits compared to those with higher incomes.

Examples

Let us use a few examples to understand the topic.

Example #1

An article published on June 10, 2024, discusses new refundable tax credits applicable to more than $3,000 for some eligible families in Colorado. Governor Jared Polis has signed new laws that introduce the Family Affordability Tax Credit and expand the Earned Income Tax Credit (EITC) to support low-income families. The Family Affordability Tax Credit, effective in 2024, provides up to $3,200 per child for the poorest families, with the aim of reducing child poverty by half and benefiting approximately 370,000 households at an estimated annual cost of $740 million. The expanded EITC will match 50% of the federal credit for the current year, stabilizing at 30% by 2026, and is expected to cost more than $200 million annually.

Example #2

Let's assume that in Old York City, everyone must pay environmental taxes based on their carbon footprints. A corporation called Zigler, a leader in environmental tech products has developed an automatically regulated solar panel that minimizes energy waste and converts 70% of solar energy into electricity. As a result, the company qualifies for a refundable credit called the eco-energy credit.

Thanks to this credit, Zigler not only reduces its environmental tax liability but also receives additional tax credits that allow further investment in local and national clean energy innovations. Since the eco-energy credit is refundable, Zigler receives a substantial payout from the government as a reward for its dedication and commitment to environmental protection.

Benefits

It provides multiple benefits as below:

It boosts the income of the low-income workers.
It makes lower-income groups more financially stable.
It establishes a fairer tax regime, giving the benefit of refund to the neediest.
It increases disposable income with the lower income group and gets them out of poverty.
Poor people in large numbers can spend more on buying goods, thus increasing goods demand & production, adding to economic activity and growth.
It provides an affordable method to employers by eliminating tracking and handling tax credits.
Low-income groups get a transparent and direct financial benefit to them.
It considerably reduces tax liability for low-income people, giving them sufficient funds to support their children's education.

Refundable vs. Non-Refundable Tax Credit

Let us use the table below to understand the topic as both relate to tax credits:

Refundable Tax Credit	Non-Refundable Tax Credit
It reduces the tax obligation of a taxpayer to zero, leading got a tax refund in cash by the IRS if the credit goes beyond tax liability.	It only reduces the tax liability of taxpayers to zero without any refund.
Tax liability becomes lower than zero.	Tax liability tends to become only zero.
Additional child credit and earned income tax certificates are examples.	Lifetime learning credit, along with child and dependent care credit, is an example.
It requires taxpayers to meet certain eligibility criteria to lay claim on refunds.	It also has certain criteria before one can claim the benefits.