US taxpayers can benefit from refundable tax credits, such as the earned income tax credit and additional child tax credit, which can result in a net payment from the treasury to the taxpayer. Tax credits are generally more valuable than tax deductions as they directly reduce taxes owed. Refundable tax credits have been subject to political controversy, with some viewing them as a subsidy or welfare payment in disguise. The earned income credit is the best-known refundable tax credit in the US.
There are many tax credits available to US taxpayers, depending on the current tax laws that establish eligibility. Some tax credits are refundable, which means that even if they reduce a person’s tax liability to less than zero, that money will be refunded. A refundable tax credit, therefore, can have the effect of returning more money to a taxpayer than they contributed to the tax system in a given tax year. Examples of refundable tax credits in the United States include the earned income tax credit and the additional child tax credit.
All tax credits, like tax deductions, reduce the amount of tax owed. Tax credits are generally considered more valuable than tax deductions, because they directly reduce taxes owed, rather than reducing the amount of taxable income, which has a much more indirect and diluting effect. For example, a person who owes $10,000 United States Dollars (USD) in taxes, who claims a tax credit of $1,000 USD, has a tax liability of $9,000 USD. However, a tax deduction of a given amount only reduces the tax liability by that amount multiplied by the person’s tax bracket. If the person in the example above is in a 25% tax bracket, a $1,000 USD tax deduction will only reduce their tax liability by $250 USD, to $9,750 USD.
However, a refundable tax credit has the greatest potential value in dollars and cents, because it is in full effect regardless of whether or not a person owes taxes. Because refundable tax credits can result in a net payment from the treasury to a taxpayer, they enjoy understandable popularity, even though they have also been the subject of political controversy. Those with a fiscally conservative or libertarian view often criticize the idea of the refundable tax credit, viewing it as a subsidy or welfare payment in disguise. Those with opposing views often point to the benefits that refundable tax credits can have for working families and a nation’s economy as a whole.
Perhaps the best-known refundable tax credit in the United States is the earned income credit, or EIC. The EIC was first enacted in 1975, and at the time had a very modest impact. However, it has since been expanded and can result in a tax credit of thousands of US dollars for a household, depending on the number of children a couple has. The exact definition of the EIC can change with tax laws, but in general, couples with more children are eligible for a higher tax credit.
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