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What Is a Refundable Tax Credit?

This article was written by in Taxes. 9 comments.


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 has been signed into law, and as other refundable credits have made the news, 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.

Updated April 1, 2011 and originally published February 17, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 9 comments… read them below or add one }

avatar RateNerd

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!

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avatar Steve

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

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avatar Pev

Hey thanks for explaining, really appreciate it.

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avatar Aryn

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.

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avatar the weakonomist

Great summary, it was a simple enough explanation. The news people never bothered to clarify that. Typical.

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avatar Steve

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.

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avatar Dan Patrick

Too bad they don’t call it what it is… welfare.

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avatar shorty

Dan P: that’s too harsh. Better to call it “wealth redistribution”.

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avatar ML

I am a school teacher who took in two of her students. The children had been in DHR for 4 years but were returned to their father. The father was arrested and sent to prison shortly after getting the children out of DHR. The children have lived with us since 1/2010. I have full custody as no other family member would take the children.

I want to adopt these children and have been working on this for a year and a half. The adoption is set to be final before the end of the year so I contacted DHR to get the special needs adoption letter. I need the adoption credit so that I can continue supporting the children. DHR informed me that because the children were not in DHR custody we would not be able to receive the credit. Is this true? I am in a panic because, without this credit, I cannot support these children and would have to give them up.

FYI: I am working three jobs so the children can stay with us. I work form 6am to 6pm. PLEASE do not tell me to hire an attorney. I simply cannot afford to feed the children and pay an attorney.

Thanks in advance for any help,
ML

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