When I first came across the term “refundable tax credit,” I have to admit I was confused about its meaning. And now that the economic stimulus bill will be signed into law today, I’ve seen that my misconception is shared by others.
A tax credit is a dollar amount that decreases the amount of tax you owe. Normally, a tax credit stops once you reach zero tax liability. However, a refundable tax credit can cause your tax liability to cross over zero, resulting in a refund. This is what is meant by “refundable.” Therefore, even if you owe no tax or had no income, a refundable tax credit might result in receiving a check from the government. In effect, there is a possibility that some people, due to refundable tax credits, may find themselves with an “negative effective income tax rate,” receiving more from the government than they put into the system.
“Refundable” does not mean that you have to pay the credit back to the government over time. Depending on the tax credit, this may be the case, but you wouldn’t be able to tell just by virtue of it being called a refundable tax credit. An example of a refundable tax credit is the Earned Income Tax Credit, designed to reduce or eliminate tax paid by low-income workers.
Refundable tax credits create the possibility for scenarios in which certain families pay no income tax and still receive a payment from the government.
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{ 8 comments… read them below or add one }
the language the IRS uses is so confusing – thanks for clearing this up. No idea why they cant hire a language consultant or someone from Disney to make it easy!
Got a quick question for you.
Let’s say I filed my taxes already, and received a refund of $800. In two weeks I close on a house, and file an amended return to get the $8,000.
Will I be able to get the entire $8,000 back, or will my total refund (including the 800 I already received) be capped at 8k, thus only giving me a $7,200 refund for the new home buyer credit?
Thanks,
Steve
Hey thanks for explaining, really appreciate it.
My friend is in this situation. She’s a single parent with sole custody. Because her income is also low, she receives more money back than she paid. It’s mostly due to the child credit and earned income credit.
To answer Steve, you’ll apply the credit to your 2009 taxes, not the 2008 taxes you already filed. And it isn’t a straight $8K, there are other limitations that I’m sure will be included in the forms/software.
Great summary, it was a simple enough explanation. The news people never bothered to clarify that. Typical.
Aryn,
I was under the impression that people are allowed to file an amended return to their 2008 tax returns in order to receive this money sooner.
Too bad they don’t call it what it is… welfare.
Dan P: that’s too harsh. Better to call it “wealth redistribution”.