The Small Business Jobs Act of 2010 has been one of many controversial pieces of legislation that have become law this year. Right here on OPEN Forum there were differing opinions on the value and efficacy of the legislation, as you can see here and here. While this debate will continue for some time, business owners need to make decisions on how to take advantage of specific provisions of the law that impact their businesses. Failing to do so may cost you many thousands of dollars or more in potential tax savings.
As 2010 comes to a close, it’s time to take a look at the provision of the law which extends the carryback period for the general business tax credit. How does this provision impact your company’s tax bill? Let’s take it step by step.
How do tax credits work?
Tax credits are a great thing! They are very different than a tax deduction. A tax credit reduces the amount of money you owe in taxes dollar for dollar. For example, if your company had taxable income of $1 million, then using the current tax rate table it would owe $340,250 in income taxes. If the company also qualified for a $40,250 tax credit, then this amount would be subtracted directly from the amount due in taxes. The new amount due would be $300,000, saving your company the full amount of the credit.
This is very different from a tax deduction. Deductions reduce the “taxable income” which serves as the basis for calculating your tax liability. If the $40,250 in this example was instead a deduction, then it would be subtracted from the $1 million, leaving $959,750 in taxable income. This would lead to a $326,656 tax bill. While the deduction still reduces the amount due for taxes, the savings pale in comparison to that offered by the credit.
For many tax credits, there are specific parameters that your company must meet in order to qualify and the amount of the credit may also vary depending on the specifics of your case. Typically a tax form needs to be prepared and included with your tax return showing the calculation for the credit.
What is the general business credit?
The U.S. tax code is filled with many credits that exist for political, economic, social and other reasons. The carryback provision of the 2010 Small Business Jobs Act impacts the “general business credit” of your company. Despite the singular form of the name, the general business credit represents the total dollar value of the credits for which your business qualifies. Each credit has specific requirements for qualification.
The credits included are:
- Agricultural chemicals security credit (Form 8931)
- Alcohol and cellulosic biofuel fuels credit (Form 6478)
- Alternative fuel vehicle refueling property credit (Form 8911)
- Alternative motor vehicle credit (Form 8910), consisting of the following credits for certain vehicles you placed in service:
- Qualified fuel cell motor vehicle credit
- Advanced lean burn technology motor vehicle credit
- Qualified hybrid motor vehicle credit
- Qualified alternative fuel motor vehicle credit
- Qualified plug-in electric drive motor vehicle credit, for a vehicle converted, and then placed in service after February 17, 2009.
- Biodiesel and renewable diesel fuels credit (Form 8864)
- Carbon dioxide sequestration credit (Form 8933)
- Credit for employer social security and Medicare taxes paid on certain employee tips (Form 8846)
- Credit for employer differential wage payments (Form 8932)
- Credit for employer-provided childcare facilities and services (Form 8882)
- Credit for increasing research activities (Form 6765)
- Credit for small employer pension plan startup costs (Form 8881)
- Credit for affected Midwestern disaster area employers (Form 5884-A)
- Disabled access credit (Form 8826)
- Distilled spirits credit (Form 8906)
- Empowerment zone and renewal community employment credit (Form 8844)
- Energy efficient appliance credit (Form 8909)
- Energy efficient home credit (Form 8908)
- Indian employment credit (Form 8845)
- Investment credit (Form 3468), which is the total of the following credits:
- Rehabilitation credit
- Energy credit
- Qualifying advanced coal project credit
- Qualifying gasification project credit
- Qualifying advanced energy project credit
- Low sulfur diesel fuel production credit (Form 8896)
- Low-income housing credit (Form 8586)
- Mine rescue team training credit (Form 8923)
- New markets credit (Form 8874)
- Nonconventional source fuel credit (Form 8907)
- Orphan drug credit (Form 8820)
- Qualified plug-in electric drive motor vehicle credit (Form 8936)
- Qualified plug-in electric vehicle credit (Form 8834, Part I only)
- Qualified railroad track maintenance credit (Form 8900)
- Renewable electricity, refined coal, and Indian coal production credit (Form 8835)
- Work opportunity credit (Form 5884)
See this page on the IRS website for more information on these credits.
Want more tax tips? Check out these stories:
- Last-Minute Business Tax Deductions for 2010
- Tax Rules You Should Know About for 2011
- New Tax Breaks for the Swift
What are carryforwards and carrybacks?
Sometimes your company may qualify for a tax credit in a given year but may not have sufficient taxable income to take advantage of it. For example if your company has a $20,000 tax liability but qualifies for $100,000 in tax credits, then the first $20,000 of the credit would be used to bring your tax bill to zero, but the remaining $80,000 would go to waste since your company hasn’t earned enough money to owe enough in taxes to use the credit. This is where carryforwards and carrybacks enter the picture.
A carryforward allows you to “carry forward” the unused credit (the $80,000 in this case) into future tax years so you can use it to offset the taxes due on profits you will earn in the future. This way you don’t waste the tax credit. Usually you can keep carrying forward credits for many, many years.
A carryback has the same benefit, but in the opposite direction. It allows you to offset taxes already paid for previous years by allowing you to “carry back” the credit you earned this year. You are basically getting back part of the money your company paid in taxes for previous years. You can’t go back forever though. There are limits.
So is it better to carry back or carry forward?
When considering this question, it’s always important to consult your tax advisor or accountant before making any decisions. In my opinion -- and assuming all else being equal -- carrybacks are better because you obtain the cash benefit now. With the carryforward, you have to wait until your company has sufficient profitability to use the tax credit. You may find that after a few years of losses, you may have accumulated a significant amount in unused tax credits which could take years to use up. Tax laws can also change at any time, so you run the risk of being adversely impacted by waiting. However if you expect a big jump in profits and an increase in your marginal tax rate due to a new contract or big sale, then it may make sense for your company to carry forward.
How does the 2010 Small Business Jobs Act change the carryback provisions?
There are two important changes relating to carrybacks thanks to the 2010 Small Business Jobs Act. First, the period for “carrying back” credits earned in the 2010 tax year has been extended to five years. This is very valuable because many companies were doing well five years ago, made money and paid big tax bills. Given the state of the economy over the past few years, there is a good chance that your company didn’t have sufficient profits to take advantage of a carry back on last year’s income. So by allowing you to “reach back” to a period of profitability, your company can take advantage of the carryback now when it may be in need of cash.
The second important benefit is that the carryback can now be applied to the Alternative Minimum Tax (“AMT”) as well. This provides additional tax liability to offset the credit. If you had a large AMT bill, then this is very helpful.
How do I know if my business qualifies?
In order to qualify for the carryback provisions of the 2010 Small Business Jobs Act, your business cannot have exceed $50 million in average annual gross receipts for the previous three tax years. If it is a corporation it cannot be publicly traded. Your company must also qualify for the individual credits you are seeking to apply.
So how do I apply the carryback provision?
Before applying the carryback provision, you need to determine your eligibility for tax credits for the 2010 tax year. You must include form 3800 and any forms required for the credits you are claiming with your tax return. Forms are available here.
To keep the process clean and organized, you should start with the earliest possible tax year permitted under the carryback provision. Since this provision applies to credits earned for tax year 2010 and it goes back five years, apply as much of the credit to tax year 2005. If your company did not earn enough money to use up the credit, then after bringing your tax liability to zero for 2005, apply the remaining credit to the tax liability paid for 2006. Continue this process through tax year 2009 or until you have exhausted the credits earned in 2010.
Remember that this special provision applies to credits earned in 2010. You may have other credits from previous years that would follow their existing parameters. Don’t mix them up with the 2010 credits.
Despite differing opinions on the efficacy of the 2010 Small Business Jobs Act, the act is now law and many businesses can benefit from this carryback provision. Share this article to your accountant or tax advisor and make sure that the topic is on the agenda for your next meeting with them. 2011 is just around the corner and this is an important part of your tax year 2010 decision-making.
Mike Periu is the founder of EcoFin Media, LLC an independent producer of financial, economic and entrepreneurial content for television, radio, print and the internet. Over the past ten years he has started three companies and advised over 50 companies on financial strategies including fundraising. Mike also hosts regular small business webinars on a range of topics relevant to business owners.