Just as deductions offset business income, tax credits offset tax liability. In effect, tax credits are considerably more valuable than deductions since they offset taxes on a dollar-for-dollar basis.
Businesses may be entitled to a variety of credits that Congress created to encourage certain activities—hiring special workers, using alternative energy sources, pouring money into research, providing health coverage for your staff, and so on. Not every business credit applies to small business owners (but most of the business-related credits are listed within this chapter to alert you to their existence).
Many of these credits have been discussed throughout this book in the chapter to which they relate. However, here you will find a roundup of business tax credits, a brief explanation of what they are all about, and where you can find more information on them within this book (see Table 23.1, page 539). Some personal credits that have a business connection are explained in this chapter, but education tax credits are explained in Chapter 22.
Table 23.1 Guide to Tax Credits
Business Credits |
Tax Form |
More Info |
Alcohol fuels credit |
Form 6478 |
|
Alternative fuel vehicle refueling property credit |
Form 8911 |
|
Alternative motor vehicle credit |
Form 8910 |
|
Credit for FICA tax on tips |
Form 8846 |
|
Disabled access credit |
Form 8826 |
|
Employer-provided child care facilities and services credit |
Form 8882 |
Chapter 23 |
Employer differential wage payment credit |
Form 8932 |
|
Empowerment zone employment credit* |
Form 8844 |
|
Energy-efficient home credit* |
Form 8908 |
Chapter 23 |
Enhanced oil recovery credit |
Form 8830 |
|
Federal excise tax on fuel |
Form 4136 |
|
Foreign tax credit |
||
corporations |
Form 1118 |
|
individuals |
Form 1116 |
|
General business credit |
Form 3800 |
Chapters 7 and 23 |
Indian employment credit* |
Form 8845 |
|
Investment credit (rehabilitation credit, energy credit, advanced coal project credit, and qualifying gasification project credit) |
Form 3468 |
|
Minimum tax credit |
||
corporations |
Form 8827 |
|
individuals |
Form 8801 |
|
New markets credit |
Form 8874 |
Chapter 23 |
Orphan drug credit |
Form 8820 |
|
Plug-in electric drive motor vehicle credit |
Form 8834 |
|
Research credit |
Form 6765 |
|
Small employer health insurance credit |
Form 8941 |
|
Small employer pension plan startup costs |
Form 8881 |
Chapter 23 |
Work opportunity credit |
Form 5884 |
|
Personal Work-Related Credits |
Tax Form |
More Info |
Earned income credit |
Form EIC |
|
Education credits |
Form 8863 |
|
Dependent care credit |
Form 2441 |
|
Premium tax credit |
Form 8962 |
*These credits expired at the end of 2016 but could be extended for 2017; check the Supplement for details.
The tax law encourages you to hire certain workers by permitting you to claim tax credits for certain wages you have paid.
The work opportunity credit applies for hiring workers from certain economically disadvantaged designated groups:
Recipient of Temporary Assistance for Needy Families (TANF) (someone who is a member of a family receiving TANF or its predecessor, AFDC, for any 9 months during the past 18 months ending on the hire date).
Qualified veteran (someone with a service-related disability who has been unemployed for any 6 months or more during a one-year period ending on the hire date).
Qualified ex-felon (someone convicted of a felony under any statute of the United States or any state, who received food stamps for at least 3 months during the 12-month period ending on the hiring date, and is hired not more than one year after the date of conviction or release from prison).
Designated community resident (someone at least age 18, but not yet 40, on the hiring date, who resides in an empowerment zone, enterprise community, renewal community, or rural renewal community).
Summer youth employee (someone 16 or 17 years old who performs services between May 1 and September 15, and who resides in an empowerment zone, enterprise community, renewal community, or rural renewal community).
Vocational rehabilitation referral (someone certified as having a physical or mental disability that constitutes a substantial hardship to employment, including an individual participating in the Ticket to Work and Self-Sufficiency Program).
Food stamp recipient (someone at least age 18, but not yet 40, on the hiring date who received food stamps for at least 3 months during the 12-month period ending on the hiring date).
Supplemental Security Income recipient (someone receiving SSI for any month ending within 60 days of the hiring date).
Long-term family assistance recipient (a member of a family that received long-term family assistance for at least 18 months ending on the hiring date, or who is no longer eligible for assistance and is hired within 2 years of the expiration of eligibility).
Returning heroes: 40% of the first $6,000 of wages (top credit of $2,400) for hiring a veteran who has been unemployed at least 4 weeks but less than 6 months in the year preceding the hiring date; 40% of the first $14,000 of wages (top credit of $5,600) for hiring a veteran who has been unemployed at least 6 months in the prior one-year period.
Wounded warriors (those with a service-related disability): 40% of the first $12,000 of wages (a top credit of $4,800) for hiring any such veteran within a year of release from active duty; 40% of the first $24,000 of wages (top credit of $9,600) for hiring a veteran with service-connected disabilities who has been unemployed at least 6 months in the year preceding the hiring date.
Long-term unemployed (someone who is unemployed at least 27 weeks and receiving government unemployment benefits)
To claim the credit, you must submit Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, to your state workforce agency within 28 days of the worker's start of employment.
As a good business practice, have all newly hired workers automatically sign the form (if applicable) when completing other paperwork (e.g., when signing Forms I-9 and W-4) so you can submit the form within the time limit. Do so even if the credit has not been extended by the time of hiring and your state holds your form and does not immediately process it; this will avoid forgetting to do this if the credit is extended.
The work opportunity credit is set to expire at the end of 2019 unless Congress extends it. See the Supplement for any update.
If you own a food or beverage business, you may claim a credit for the employer portion of Social Security and Medicare taxes (FICA) on tips in excess of those treated as wages for purposes of satisfying the minimum wage provisions of the Fair Labor Standards Act. The credit applies to tips both on premises as well as off premises (e.g., earned for pizza deliveries). The credit is based on the old federal minimum wage rate of $5.15 per hour (even though the basic federal minimum wage rate is $7.25 per hour).
The empowerment zone employment credit expired at the end of 2016, but could be extended by Congress for 2017. The following is included in case there is an extension. Check the Supplement for details. This credit is 20% of the first $15,000 of wages and may be claimed for workers who reside in and perform services for an employer located within designated empowerment zones. Wages taken into account for the work opportunity credit may not also be used for the empowerment zone employment credit.
The Indian employment credit expired at the end of 2016, but could be extended by Congress for 2017. The following is included in case there is an extension. Check the Supplement for details. This credit is 20% of the first $20,000 in wages and health care costs in excess of amounts paid in 2003 and may be claimed for employing Indian tribe members who live and work on a reservation. The top credit is $4,000 per employee.
If you continue some or all of the wages of employees called to active duty (called a differential wage payment), you can take a tax credit of 20% of the differential that does not exceed $20,000. This credit applies only to small employers (on average fewer than 50 employees) that have a written plan to provide the wage differential. No deduction for compensation can be claimed if the compensation is a differential wage payment used to determine this credit.
If you work as an employee or as a self-employed person, you may be eligible for certain personal tax credits. Personal credits for education are discussed in Chapter 22.
Workers with wages or self-employment income whose income is below threshold amounts may be eligible to claim an earned income credit. This credit is a type of negative income tax—it may be paid even though it exceeds tax liability. The amount of the credit depends on the number of qualifying dependents, if any, and AGI.
Whether you are an employee or a business owner, if you hire someone to look after your child under age 13 or a disabled spouse or disabled child of any age so that you can go to work, you may claim a personal tax credit. The credit is a sliding percentage based on your AGI. The top percentage is 35%, but scales back to 20% for AGI over $43,000. The percentage applies to eligible expenses up to $3,000 for one dependent and $6,000 for 2 or more dependents.
The status of the individual mandate and the premium tax credit were in doubt when this book was published. The following information is included in case no changes are made. Check the Supplement for any update. Whether you are an employee or a self-employed individual, you must have minimum essential health coverage in order to avoid a penalty. If you do not have such coverage through an employer (yours or your spouse’s) or a government plan (e.g., Medicare), and you cannot afford coverage, you may be eligible for a tax credit to help pay the premiums. The credit is explained in Chapter 19.
The tax law encourages certain types of construction.
If you make capital improvements to make your premises more accessible to the handicapped, you may qualify for a credit of 50% of expenditures over $250, but not over $10,250. Thus, the top credit is $5,000. If you claim this credit, you cannot claim depreciation on these costs.
If you invest in the construction or rehabilitation of housing for low-income individuals, you may be eligible for a tax credit of 70% of new construction or 30% of federally subsidized buildings. The credit is claimed over a 10-year period.
If you rehabilitate or reconstruct certain buildings, you may claim a credit of 10% of your costs if the building was originally placed in service before 1936. If the building is a certified historic structure listed on the National Register of Historic Places, the credit is 20% of your expenditures. To qualify, your expenditures must be more than the greater of $5,000 or your adjusted basis in the building and its structural components.
To encourage investments in certain economically disadvantaged areas, you may claim a credit for purchasing stock in a community development entity (CDE). A CDE is a domestic corporation or partnership that provides investment capital for low-income communities or persons, maintains accountability to the residents of the area, and has been certified as a CDE by the Community Development Financial Institutions (CDFI) Fund of the Department of the Treasury. The credit is claimed over a period of 7 years. The amount of the credit is the equity investment multiplied by 5% in years one through 3 and 6% in years 4 through 7. The credit is subject to recapture if the CDE ceases to be qualified, the proceeds cease to be used to make qualified investments, or the investment is redeemed by the entity (there is no recapture if you merely sell your investment).
The new markets credit expires at the end of 2019 unless Congress extends it. See the Supplement for any update.
The energy-efficient home credit expired at the end of 2016, but could be extended by Congress for 2017. The following is included in case there is an extension. Check the Supplement for details. To encourage the construction of energy-efficient homes, contractors may qualify for a tax credit of up to $2,000 per dwelling unit for site-built homes or $1,000 or $2,000 (depending on energy conservation) for manufactured homes. To qualify for the credit, a home must be certified to provide a level of heating and cooling energy consumption that is at least 30 to 50% in the case of a manufactured home, and 50% for other homes, below that of a comparable home constructed in accordance with the standards of the 2004 Supplement to the 2003 International Energy Conservation Code. It must also have building envelope component improvements providing a level of heating and cooling energy consumption that is at least 10% below that of a comparable home.
Other tax credits in the law are intended to encourage specific things—research, alternative energy improvements, and so on.
If you pay more than half of your employees' health care costs and meet certain payroll limits, you may qualify for a tax credit of up to 50% of your premiums as long as you obtained the coverage through the Marketplace (a government exchange). This credit is explained in Chapter 19.
You can claim a credit for providing child care facilities and child care referral services. The credit is 25% of qualified facility expenses, plus 10% of referral service costs, for a maximum credit of $150,000. If a company builds a child care facility, the basis of the facility for purposes of depreciation must be reduced by the expenses taken into account in figuring the credit. If the facility ceases to be used for child care within 10 years, the credit is subject to recapture.
If you engage in search and experimentation, you may claim a credit of 20% of increased research activities (increased costs this year compared with a base period). This credit, which was first introduced in 1981, has expired and been renewed numerous times since then. It is now permanent.
For companies long in existence, the base period is 1984 to 1988 (“existing company rule”). For others, it is 3 years of a fixed base period (“start-up company rule”); this also applies to older companies that did not previously have research expenses.
Alternatively, you may claim an alternative simplified credit, which works best for a company that had little or no R&D spending in the previous 3 years. This credit is 14% of the amount of current-year R&D spending that exceeds 50% of the average spent in the previous 3 years. This alternative is figured without regard to gross receipts. The alternative simplified credit can be elected on an original or amended return.
Special options for small businesses. Instead of using the research credit to offset regular income tax, there are two other offset options. Small businesses that do not have sufficient tax liability to benefit from the research credit may be able to use the credit as an offset to the employer's Social Security tax liability, up to $250,000. To be eligible, the business must:
A second offset option is to use the research credit to offset alternative minimum tax liability. This option is available to businesses with average annual gross receipts of $50 million or less in the 3 prior years. For partnerships and S corporations, the owners must also satisfy this gross receipts test individually.
The credit applies to alcohol (ethanol and methanol) you sold or used as fuel in your business.
The credit applies to certain oil recovery costs if you are in the oil and gas business.
The federal excise tax you pay on certain fuels used in your business (particularly farming activities) may be claimed either as a credit or a tax refund. The credit is the amount of this tax paid on fuel used in machinery and off-highway vehicles (such as tractors) and on kerosene used for heating, lighting, and cooking on a farm.
If you pay tax to a foreign country—on business income or investments made abroad—you may be eligible for a tax credit. The purpose of the tax credit is to prevent you from paying tax twice on the same income (once to a foreign country and again on your federal income tax).
There is an energy tax credit (which is part of the investment credit) for a specified percentage of the basis of each qualified energy property placed in service.
The credit is the cost of selling electricity produced from alternative energy sources within 10 years of placing the production facility in service.
The alternative fuel vehicle refueling property credit expired at the end of 2016, but could be extended by Congress for 2017. The following is included in case there is an extension. Check the Supplement for details. If you install certain refueling property for your business for the purpose of storing or dispensing clean burning fuel or electricity, you may claim a credit of up to $30,000. Find details in Chapter 9.
Small employers (those with no more than 100 employees who received at least $5,000 of compensation in the preceding year) may claim a tax credit for starting up a qualified retirement plan. The credit is 50% of administrative and employee-education expenses up to $1,000, for a top credit of $500. The credit may be claimed for 3 years, starting with the year in which the plan becomes effective or the prior year. (This credit is explained in Chapter 16.)
If your business engages in research on diseases and afflictions that are not widespread, you may claim a special credit for your related expenses.
This credit is the sum of 2 tax credits: the biodiesel mixture credit and the biodiesel credit. There is a higher credit limit for agribiodiesel.
Small business refiners can claim a credit for the production of low-sulfur diesel fuel that complies with the EPA's Highway Diesel Fuel Sulphur Control Requirements. A small refiner is one with an average daily domestic refinery run for a one-year period ending on December 31, 2002, that is 205,000 barrels or less and cannot employ more than 1,500 individuals on any day during the year.
The credit is $3 per barrel of qualified crude oil production and 50¢ per 1,000 cubic feet of qualified natural gas production.
If you paid AMT in a prior year, you may be eligible for a tax credit this year. Different rules apply to individuals and C corporations. (This credit is explained in Chapter 28.)
Most tax credits discussed in this chapter are part of the general business credit. This means that after figuring each separate credit, there is an overall limit to credits under the general business credit. Total credits in excess of these limits can be carried back and/or forward within limits.
The general business credit is composed of the following (some credits that are applicable only to large companies are not included here):
Investment credit (rehabilitation credit, renewal energy credit, and the credit from cooperatives)
Research credit
Low-income housing credit
Distilled spirits credit
Disabled access credit
Renewable electricity production credit
Indian employment credit*
Orphan drug credit
Credit for contributions to selected community development corporations
Credit for employer-provided child care facilities and services
Credit for small employer retirement plan start-up costs
New markets credit
Biodiesel and renewable diesel fuels credit
Low-sulfur diesel fuel production credit
Marginal oil and gas well production credit
Energy-efficient homes credit*
Alternative motor vehicle credit
Alternative fuel vehicle refueling property credit*
Credit for employer differential wage payments
Plug-in electric drive motor vehicle credit
Work opportunity credit
Small employer health insurance credit
*These credits expired at the end of 2016 but could be extended for 2017.
The empowerment zone employment credit, which expired at the end of 2016 but could be extended for 2017, is not part of the general business credit and is not subject to the general business credit limitations. Excess empowerment zone credits may be carried over in a manner similar to the general business credit.
First, you figure each separate credit of the general business credit and then total them. The total is then subject to special limits, determined by your regular and alternative minimum tax liability and certain other tax credits. Your limit is your net tax liability (regular tax reduced by certain personal credits, including the foreign tax credit), reduced by the greater of:
Your tentative AMT liability (figured before comparing it with regular tax).
25% of regular tax liability (before personal tax credits) over $25,000.
Small business credits in the general business credit can offset AMT liability of eligible small businesses (gross receipts not exceeding $50 million).
If the credit limitation prevents you from claiming the full general business credit that you are otherwise entitled to, you do not lose the benefit of this excess amount—you simply cannot claim it in the current year. You may be able to use the excess credit to offset your tax liability in prior and/or future years.
You may carry back the excess amount of credits for one year. If there continues to be an excess, you may then carry forward the excess up to 20 years.
If you still have unused amounts and the carryforward period expires or the business ceases (or you die), the unused amounts may be deducted in the year after the carryforward expiration or in the year of business cessation (or death). However, to the extent the credit relates to the research credit, it must be cut in half before deducting it.