Refundable Versus Nonrefundable Tax Credits
The maximum value of a nonrefundable tax credit is capped at a taxpayer’s income tax liability. In contrast, taxpayers receive the full value of their refundable tax credits. The amount of a refundable tax credit that exceeds income tax liability is refunded to taxpayers.
Most tax credits are nonrefundable. Notable exceptions include the fully refundable earned income tax credit (EITC), the premium tax credit for health insurance (PTC), the refundable portion of the child tax credit (CTC) known as the additional child tax credit (ACTC), and the partially refundable American opportunity tax credit (AOTC) for higher education. With the EITC, PTC, and ACTC, taxpayers calculate the value of these credits and receive the credit first as an offset to taxes owed, with any remainder paid out as a refund. With the AOTC, if the credit fully offsets taxes owed, 40 percent of the remainder can be paid out as a refund.
Budget Treatment of Refundable Versus Nonrefundable Tax Credits
The federal budget distinguishes between the portion of a tax credit that offsets income tax liability and the portion that is refundable, classifying the latter as an outlay. Most of the EITC—an estimated $65.6 billion of the 2019 total of $68.3 billion—was refunded. Much less of the child tax credit ($40.1 billion out of $115 billion) was refunded (figure 1). The 2017 Tax Cuts and Jobs Act substantially changed the child tax credit for 2018 through 2025, including doubling the maximum credit to $2,000 per child under age 17 while limiting the maximum refundable amount to $1,400 (this amount will increase with inflation up to $2,000.) The TCJA also created a nonrefundable credit worth $500 per dependent not qualifying for the full $2,000 credit. Before this change, expenditures on the child tax credit totaled $54.3 billion, with just over half delivered as refundable credits. In FY2019, expenditures from the CTC totaled an estimated $115 billion; of which 35 percent was refundable.
Advantages and Disadvantages of Refundable Credits
Proponents of refundable credits argue that only by making credits refundable can the tax code effectively carry out desired social policy. This is especially true for the EITC and the CTC: if the credits were not refundable, low-income households most in need of assistance would not benefit from them. Furthermore, allowing credits only against income tax liability ignores the fact that most low-income families also incur payroll taxes.
Opponents of refundable credits, for their part, raise a host of objections:
- The tax system should collect taxes, not redistribute income.
- The government should not use the tax system to carry out social policies.
- Refundable credits increase administrative and compliance costs, and enable fraud.
Updated January 2024
FAQs
Nonrefundable credits can only take the tax liability to zero (so that the taxpayer does not owe any tax). They do not create a refund. Refundable credits can actually produce a refund for the taxpayer, even if the taxpayer does not have a tax liability (owe any taxes).
What is considered a refundable credit? ›
A refundable tax credit is a credit you can get as a refund even if you don't owe any tax. Tax credits are amounts you subtract from your bottom-line tax due when you file your tax return.
What is the difference between the refundable and nonrefundable ERC? ›
Unlike the nonrefundable portion, the refundable part of the ERC can reduce an employer's total tax liability below zero. Therefore, an employer claiming the ERC on Form 941-X will likely generate a tax refund larger than the amount actually paid or assessed for a qualified period.
What is refundable and non-refundable? ›
Taxpayers subtract both refundable and nonrefundable credits from the income taxes they owe. If a refundable credit exceeds the amount of income taxes owed, the difference is paid as a refund. If a nonrefundable credit exceeds the amount of income taxes owed, the excess is lost.
What does refundable credit mean on transcript? ›
Refundable Credit: Occurs when the amount of a credit is greater than the tax owed. Taxpayers not only can have their tax reduced to zero; they can also receive a "refund" of excess credit.
What does nonrefundable credit mean? ›
A nonrefundable tax credit is a reduction in the amount of income taxes that a taxpayer owes. It can reduce the amount owed to zero, but no further.
How do I know if my tax credit is refundable? ›
Some tax credits are refundable. If a taxpayer's tax bill is less than the amount of a refundable credit, they can get the difference back in their refund. Some taxpayers who aren't required to file may still want to do so to claim refundable tax credits. Not all tax credits are refundable, however.
What happens to the non refundable ERC credit? ›
If the credit is higher and non-refundable as opposed to owed taxes, you'll lose the surplus amount. In Employee Retention Credit, the non-refundable part amounts to 6.4% of the paid wages.
Who is eligible for ERC credit? ›
To qualify for ERC, you need to have been subject to a qualifying government order related to COVID-19 that caused a full or partial suspension of your trade or business operations. The government order may be at the local, state or federal level.
Do you have to pay the ERC credit back? ›
The Employee Retention Credit is a fully refundable tax credit that eligible employers claim against certain employment taxes. It is not a loan and does not have to be paid back. For most taxpayers, the refundable credit is in excess of the payroll taxes paid in a credit-generating period.
The American opportunity tax credit (AOTC), for example, provides a tax credit of up to $2,500 for students or parents paying college tuition. The AOTC is partially refundable at 40%, so qualifying taxpayers can receive up to $1,000 as a refund—but not the full $2,500.
What is an example of a non refundable policy? ›
All Sales Are Final. Please carefully review your order before confirming your purchase. All sales are considered final. We do not offer refunds or exchanges for any products or services sold through [Insert Company Website or Platform].
What does nonrefundable mean? ›
Britannica Dictionary definition of NONREFUNDABLE. 1. of something you buy : not allowed to be returned in exchange for the money you paid. The tickets are nonrefundable unless the show is canceled.
Why is my refund amount different on my transcript? ›
Why is my refund different than the amount on the tax return I filed? (updated December 22, 2023) All or part of your refund may be offset to pay off past-due federal tax, state income tax, state unemployment compensation debts, child support, spousal support, or other federal nontax debts, such as student loans.
What is the difference between refundable and refundable child tax credits? ›
The child tax credit is nonrefundable. A refundable tax credit allows taxpayers to lower their tax liability to zero and still a receive a refund. The additional child tax credit is refundable.
Are we getting $3600 per child? ›
How has the Child Tax Credit changed over the years? The American Rescue Plan raised the maximum Child Tax Credit in 2021 to $3,600 per child for qualifying children under the age of 6 and to $3,000 per child for qualifying children ages 6 through 17.
Which of the following is not a refundable tax credit? ›
The non-refundable tax credits are Additional Child Tax Credit and Earned Income Credit. These credits reduce the amount of income tax that an individual or family owes, but they are not refundable, meaning they cannot generate a tax refund that exceeds the tax liability.
Is a dependent a refundable credit? ›
Credit for Other Dependents: If you have a qualifying relative as a dependent on your return, you're entitled to claim a nonrefundable credit of up to $500. You can claim this for each qualifying relative you have on your tax return.
Is earned income credit refundable or nonrefundable? ›
You may qualify for the earned income tax credit (EITC) if you worked last year but earned a low or moderate income. EITC is a refundable tax credit, which means that even if you don't owe any tax, you can still receive a refund.
