Refundable vs. Nonrefundable Tax Credits

What Are Tax Credits?

Tax credits lower your tax liability by providing a direct credit to your tax bill. Tax credits lower your tax bill dollar for dollar, as opposed to tax deductions, which lower your taxable income.

In terms of savings, tax credits are generally more valuable than tax deductions. Here’s why: If the upper limit of your income is in the 22% tax bracket, a $2,000 tax deduction can reduce your tax bill by up to $440. However, a $2,000 tax credit lowers your tax bill by $2,000.

Tax credits fall into two main categories: refundable or nonrefundable. Say you qualify for a $2,000 tax credit but your tax bill is only $1,200. A nonrefundable tax credit eliminates your $1,200 tax liability and stops there. A refundable tax credit, on the other hand, wipes out your liability and pays you the remaining $800 in a tax refund.

Some tax credits are partially refundable. 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.

Which Tax Credits Are Refundable?

The majority of tax credits are nonrefundable, but a handful of commonly used tax credits are refundable. The following three tax credits are at least partially refundable:

Child Tax Credit

Although the expanded child tax credit of 2021—which sent advance monthly payments to parents for six months in 2021 as part of the American Rescue Plan Act—is over, the original child tax credit is once again available to parents of children under 17. The child tax credit provides up to $2,000 per child with a partial refund of up to $1,500 in 2022.

To qualify, the child must have lived with the taxpayer for at least half the year and received at least half their support from the taxpayer.

Earned Income Tax Credit

The earned income tax credit (EITC) offers moderate- to low-income taxpayers refundable tax credits ranging from $560 to $6,935, depending on filing status, income and family size. The EITC has numerous parameters to take into account, and requirements include having earned income from employment or self-employment, a Social Security number that is valid for employment and no more than $10,300 in investment income during the 2022 tax year.

American Opportunity Tax Credit

The American opportunity tax credit (AOTC) provides partially refundable tax credits to help defray the costs of the first four years of higher education. In 2022, the AOTC provides up to $2,500 in tax credits: 100% for the first $2,000 in qualifying educational expenses and 25% of the next $2,000. The credit is partially refundable at 40%.

The taxpayer’s marginal adjusted gross income must be $80,000 or less if single or $160,000 or less if married filing jointly to qualify, with credits phasing out through $90,000 or $180,000.

Which Tax Credits are Nonrefundable?

Most tax credits fall into the nonrefundable category. Nonrefundable tax credits for individuals include:

Child and Dependent Care Credit

The child and dependent care credit (CDCTC) provides a tax credit for working taxpayers who pay for care for a child under 13 or other dependent. Last year’s CDCTC was expanded to $4,000 for a single dependent and $8,000 for two or more dependents—and it was refundable. So far in 2022, CDCTC parameters have reverted to 2020 levels: You can claim up to $3,000 for one dependent or $6,000 for two or more people, reflecting 20% to 35% of your work-related care expenses.

Credit for Other Dependents

A maximum credit of $500 may be available for each dependent on your tax return who is not eligible for the child tax credit. Dependents must meet these criteria:

• Age 17 or older
• Have individual taxpayer identification numbers (such as Social Security numbers)
• Are parents or other qualifying relatives you support
• Are non-relative dependents who live with you

This tax credit begins phasing out at $200,000 for single taxpayers and $400,000 for married couples filing jointly.

Federal Adoption Credit

If you adopted a child under the age of 18 in 2022, you may be eligible for a credit of up to $14,890 to cover court costs, attorney fees, home studies and travel expenses related to the adoption. Expenses you have already claimed through an employer’s adoption benefits program are not eligible. Your modified adjusted gross income must be $223,410 or less to qualify for the full credit: Credits phase out through $263,410.

Lifetime Learning Credit

The lifetime learning credit provides a tax credit worth 20% of up to $10,000 in qualifying education expenses for the taxpayer, their spouse or their dependent at a Department of Education accredited post-secondary institution. In 2022, your modified adjusted gross income must be no more than $80,000 for single filers or $160,000 for married couples filing jointly to claim the credit.

Residential Energy Credit

The residential energy credit provides tax credits based on a percentage of costs for energy-efficient home improvements. For tax years 2019 to 2023, the credit is 26% of your qualifying costs for the following:

• Solar electricity systems
• Energy-efficient exterior windows, doors and skylights
• Roofs (metal and asphalt) and roof products
• Insulation
• Energy-efficient heating and air conditioning systems
• Water heaters (natural gas, propane or oil)
• Biomass stoves

These improvements must meet specific standards to qualify for the tax credit. See IRS guidance for details.

Retirement Contribution Savings (Saver’s) Credit

To encourage low- and moderate-income taxpayers to save for retirement, the federal government offers a retirement contribution savings credit that provides a credit worth 10%, 20% or 50% of your total retirement savings contribution, up to $1,000 for single filers and $2,000 for joint filers.

Here’s how the credit applies, depending on your filing status and income:

*Single, married filing separately or qualifying widow(er)
Source: IRS