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Level 14

Understanding Refundable and Nonrefundable Tax Credits

So not everyone is aware that you have tax credits that are refundable and some that are not. Then, of course, you have those that are partially refundable. Almost all of us have thought to ourselves, at some point, shouldn't I get money back for this or money back for that. Well, that's not always the case. Let's get into the differences. 


Let's talk about the ones that get us money back first; yes, the refundable tax credits. Refundable credits are those that allow you a refund after your tax debt has been paid. So it's the remaining balance of the credit if that credit is larger than any tax liability (taxes you may owe) you have. This will consist of credits like the Earned Income Credit, American Opportunity Credit, First-Time Homebuyer Credit, Additional Child Tax Credit and a handful more. Not everyone qualifies for all of them. 


Next we have the nonrefundable credits. These are ones that will not give you any type of refund. So on that note, they don't generate a tax refund you'd otherwise not already be getting, and they do not give you more money to increase your refund you are expecting. These consist of credits like the Child Tax Credit, Child and Dependent Care credit, Lifetime Learning credit, Mortgage Interest Credit, and etc. Basically the purpose of these credits is to reduce your tax bill. So they get subtracted away from any income tax liability that you owe; up to the amount that you owe. They cannot reduce your tax liability pass zero. 


Finally, we have that partially refundable credit sitting out on a limb alone. This would be the only credit that fits into the category of being both refundable and nonrefundable, and I'll explain what it is and why. Drum roll please.....let's hear it for the American Opportunity Tax Credit. Yes, you read it in the list above as being a refundable credit. This is where it gets sort of complicated, so here goes. It decreases your tax liability but yet, some percentage can still be applied towards increasing your refund amount. This is why it's known as a partially refundable credit. 


The American Opportunity Credit or AOTC comes with a maximum $2500 tag, per student, per year. If you have tax liability and it reduces it down to zero, any amount left over (up to 40%) is refunded to you. So the max you can receive as a refund from this credit is $1000. Not bad, right. 


Which of these credits did you think were ones you were always supposed to receive back as money in your pocket? Or share with us ones that are not listed here. 

3 Replies
Level 4

Understanding Refundable and Nonrefundable Tax Credits

But we haven't paid any income taxes for 5 years! Yet my return claims we will receive a tax refund!!!

Level 18

Understanding Refundable and Nonrefundable Tax Credits

As AndreaC1 just pointed out, certain credits (the refundable ones) can give you a refund over and above any tax payments made. Yes, the Earned Income Credit can give you a refund even if you don't owe any (or very little) federal income tax, and didn't pay any withholding or estimated taxes during the year. This is contrary to the way that a lot of people think about refunds (that the refund is some of the money you paid in during the year being returned to you because it was more than the tax due).


On your return, are there any of the credits listed above? The credits would generally be on Schedules 3 and 5 of form 1040.

Level 11

Understanding Refundable and Nonrefundable Tax Credits

@imrupp67 You have posted to an old thread.  So it seems like you are saying that you have not filed a tax return for five years--is that right?  But the software does not know that.  If you prepared a 2018 tax return and entered 2018 income information, that is all that the TT software knows about.  So it might be showing a refund, but TurboTax does not ever know if you owe back taxes.  If you do owe taxes from earlier years, then the IRS will seize the 2018 refund shown on your 2018 return to pay toward the tax you owe.