Refundable and Non-Refundable Tax Credits | Fiscal Tax

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February 5, 2009
Refundable and Non-Refundable Tax Credits - What is the Difference?
categorized as: Tax Credits

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One of the most important things to understand when preparing your federal tax return is the difference between a refundable tax credit and a non-refundable tax credit.

Refundable tax credits, such as the Earned Income Tax Credit, are credits, which effectively count as though they were taxes paid. The earned income credit and other refundable tax credits add to the total amount that you have to paid in federal income taxes. If you do not owe taxes, all of that amount can be refunded to you.

In the case of non-refundable tax credits, the credit only counts toward taxes that are actually due. For example, some of the educational credits, are only applied when you actually owe taxes. Non-refundable tax credits will reduce the amount of taxes that you owe, but if there is a leftover credit, it is not refunded to you.

The best way to look at this is to use an example:

Let's say that you are eligible for a $1000 non-refundable tax credit. If you owe $800 in federal taxes, the non-refundable tax credit would pay that bill. However, the left over $200 of the credit is simply lost. If the $1000 credit were a refundable credit, then you would get that $200 added to your tax refund.

The most well known of the refundable tax credits is the Earned Income Tax Credit. To qualify for the earned income credit, you must have dependent school-age children or another qualifying dependent and must make less than an amount specified each year by the tax code. In many cases, people who have paid no income tax at all during the year may be eligible for the Earned Income Tax Credit based on their number of dependents and total income. Many people who would otherwise not be required to file income tax forms are often encouraged to do so because they may be granted a refund based solely on the earned income credit.

 

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