What is a refundable tax credit?

A refundable tax credit is a type of credit that can reduce a taxpayer's liability to zero and, if the credit amount exceeds the tax owed, the taxpayer can receive the excess amount as a refund. This characteristic distinguishes refundable credits from non-refundable credits, which can only reduce tax liability to zero but not provide a refund if the credit exceeds the tax owed.

For example, if a taxpayer qualifies for a refundable credit of $1,200 but only owes $800 in taxes, the taxpayer will receive the remaining $400 as a refund. This feature makes refundable credits particularly beneficial for low-income taxpayers who may not owe enough in taxes to take full advantage of non-refundable credits.

The other options do not accurately describe refundable tax credits. The first option implies that the credit does nothing beyond reducing tax liability without any refunds, which is not true for refundable credits. The third option restricts the definition of the credit to capital gains, which is not representative of all refundable tax credits, as they can apply to a variety of situations. Lastly, defining a refundable credit as applicable only to first-time homebuyers overlooks numerous other refundable credits available, such as the Earned Income Tax Credit.