Understand the Different Types of Tax Credits

Most people perk up at the possibility of getting tax credits. They can be valuable, because they reduce the amount of tax you owe, dollar for dollar. But it can be frustrating when you qualify for a bigger tax credit than you can take.

Let’s say you qualify for a nonrefundable tax credit of $3,000 and your tax liability is $800. The credit can wipe out your $800 tax liability, but the remainder evaporates. If you owe no tax for the year, this credit won’t help you at all. Examples of nonrefundable tax credits include:

• The Saver’s credit,
• The other dependent credit (for nonchild dependents),
• The Lifetime Learning credit, and
• The energy-efficient home improvement credit.

However, some tax credits are fully or partially refundable. These credits generally come with additional reporting requirements and some caveats. If you meet the conditions, you may receive a refundable tax credit, even if your tax liability is zero.

Suppose instead that you qualify for a refundable tax credit of $3,000 and your tax liability is $800. The credit can wipe out your $800 tax liability, and you may receive all or part of the remaining $2,200 as a tax refund. Depending on the specific credit, it may be fully or partially refundable.

Fully Refundable Credits

The following are examples of credits that are fully refundable:

Earned income tax credit. This credit is for lower-income individuals. To qualify, a taxpayer’s income from investment or working must fall below certain limits. If the requirements are met, the taxpayer may receive the full amount of the credit even if no tax is owed.

Premium tax credit. This credit helps individuals who buy health care coverage through the Affordable Care Act’s Health Insurance Marketplaces. It’s based on income and the cost of the health care plan. If the amount of the credit exceeds the taxes owed, the excess can be refunded to the taxpayer.

Partially Refundable Credits

Other credits may only be partially refundable, such as:

Child credit. This helps pay the costs of raising dependent children, subject to limits. A portion of this credit — known as the “additional child tax credit — may be refundable. This credit, including the refundable portion, is phased out at higher income levels, however.

American Opportunity credit. This credit may be available to those who paid qualified education expenses for an eligible college student. The maximum credit is $2,500 per student each year for the first four years of postsecondary education. Up to $1,000 of that amount may be refundable.

Claim Your Refundable Credit Carefully

The National Taxpayer Advocate (NTA) says that the rules for both types of credits are similar, but they’re more complex for refundable credits. For example, when reporting income, take note of what specific type of income is requested. Credits may be based on adjusted gross income, modified adjusted gross income, investment income, earned income or some other statutorily defined measure of income.

It’s also important to ensure that information that affects eligibility is reported accurately. For example, a credit related to children will likely define “qualifying child” with specific details, such as age limits and the child’s relationship to the taxpayer.

The NTA says that taxpayers who are audited and found to have improperly claimed credits or claimed the wrong amount could be required to pay back the credit. Depending on the details, the taxpayer could also be banned from taking the credit again for several years. A refundable credit that’s improperly claimed “due to the reckless or intentional disregard of rules and regulations,” could result in a ban for two years from taking the credit, says the NTA. If there’s evidence that a credit was claimed fraudulently, the ban could be for up to 10 years and include harsher penalties.

Look Before You Leap

If you qualify for tax credits, refundable or not, claim them. But be sure to provide your tax preparer with accurate information and retain documentation that supports the details.

These are just a few examples of tax credits available under current tax law. There are many others, and Congress sometimes adds new ones or changes the rules for existing credits. Your tax advisor can help you stay atop the latest developments to ensure you maximize the credits that are available to you under current law.

Copyright 2025

This article appeared in Walz Group’s March 3, 2025 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.