A tax credit is a dollar-for-dollar reduction in how much a taxpayer pays in taxes.

Does a tax credit amount equal the dollars I'm going to save on taxes?

Yes. If you have a tax credit of $300, you will pay $300 less in taxes than you otherwise would have. So if you owe $800 but have a $300 tax credit, you'll pay $500. A tax credit is independent of your tax rate.

Could tax credits ever add up to a tax refund for me?

It's possible, depending on the types of tax credits you have. There are two kinds of tax credits:

  • non-refundable tax credits and
  • refundable tax credits.

Non-refundable tax credits are tax credits that can bring your tax bill down to $0, but they won't generate you a refund. If there's any money remaining of the credit once your tax bill is at $0, you forfeit that extra credit. Examples of non-refundable tax credits are the adoption credit, lifetime learning credit, and alternative motor vehicle credit.

Refundable tax credits are tax credits that can generate a refund. In other words, they don't stop when your tax bill reduction hits $0. When that happens, you're basically getting a refund on taxes you never paid. Refundable credits can offset certain types of taxes that you usually can't lower in other ways. Some examples include the earned income tax credit and the child tax credit.

Anything I need to keep in mind about claiming a refundable tax credit?

The IRS takes an extra close look at tax returns that include refundable tax credits. That's because they're a favorite of fraudsters. So if you claim a refundable tax credit, don't be surprised if your tax refund is delayed, possibly until mid- or late-February.

Why were refundable tax credits created?

Both the earned income tax credit and the child tax credit were started up as anti-poverty programs and alternatives to welfare. They incentivize work by significantly reducing the tax burden of work on lower-income families.

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