When I go in to do a credit memo it only lets me refund everything (full amount). I do not have the option to change to quantities to refund, that is not an editable field for me. Why is that? Do I need to change a setting or install an extension to make that feature available? I want to be able to partially refund if they only are returning 1 item.
Depends on your payment provider and if the extension/code supports partial refund
It seems your store lacks an option of partial refund (however, it's hard to state it for sure).
You can have a look at this RMA module that allows returns per item.