Federal tax credits are offered to businesses as a way to promote certain activities such as investing in new technologies or using more environmentally friendly sources of energy. The government believes that these activities are beneficial to society as a whole and tries to motivate private businesses to undertake them by lowering the cost to as low as zero. A tax credit can reduce your income tax liability dollar for dollar. It can be more valuable than a tax deduction, which only serves to lower your taxable income.
For example, a company with $500,000 in taxable income would have a federal income tax liability of $170,000, or 34 percent of its income. If the company qualifies for a $50,000 tax deduction, then the taxable income would be reduced to $450,000 and the tax liability would drop to $153,000. So the $50,000 deduction reduced the tax bill by $17,000.
If instead the company had a $50,000 tax credit, it would pay only $120,000 in federal income taxes. The credit represents an additional $33,000 in after-tax income to the business. If your company generates a 10 percent pre-tax profit margin, then that extra boost from the tax credit versus the deduction can offer the same “profitability” as generating an extra $330,000 in revenues.
The General Business Tax Credit
Over $90 billion per year in general business tax credits are claimed by businesses. In my experience though, the General Business Tax Credit (GBTC) is one of the least understood credits available to business owners.
Despite the singular form of the name, it actually consists of over two dozen individual credits that are grouped together under the GBTC name. It could very well be that your company is already spending money on some of the activities that qualify for a credit. The following credits are part of the GBTC:
- Work Opportunity Credit
- Alcohol and Cellulosic Biofuel Fuels Credit
- Credit for Increasing Research Activities
- Low-Income Housing Credit
- Recapture of Low-Income Housing Credit
- Orphan Drug Credit
- Disabled Access Credit
- Qualified Plug-in Electric and Electric Vehicle Credit
- Renewable Electricity, Refined Coal, and Indian Coal Production Credit
- Empowerment Zone and Renewal Community Employment Credit
- Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips
- Credit for Contributions to Selected Community Development Corporations
- Biodiesel and Renewable Diesel Fuels Credit
- New Markets Credit
- Credit for Small Employer Pension Plan Startup Costs
- Credit for Employer-Provided Childcare Facilities and Services
- Distilled Spirits Credit
- Energy Efficient Home Credit
- Alternative Motor Vehicle Credit
- Alternative Fuel Vehicle Refueling Property Credit
The following are also included in the general business tax credit, but are directed towards a very small number of companies:
- Mine Rescue Team Training Credit
- Nonconventional Source Fuel Credit
- Qualified Railroad Track Maintenance Credit
- Low Sulfur Diesel Fuel Production Credit
- Indian Employment Credit
- American Samoa Economic Development Credit
- The rehabilitation, energy, and reforestation credits, together known as the Investment Credit
More information can be found here on the specifics of each tax credit. To apply for the GBTC, you need to fill out IRS Form 3800 plus an additional form for each credit you plan to take.
Tax Credit Planning
An important benefit of the General Business Tax Credit is that it isn’t bound by the limits of spacetime. Remember that the GBTC can reduce your tax liability. But if your business doesn’t make money, then you don’t owe income taxes and can’t use the credit even if you qualify for it. The IRS allows you to apply the credit to future years when you do have profitability. The IRS also allows carrybacks. So if you can’t use the credit this year because your business didn’t earn enough money, you can apply the credit to a previous year’s income to reduce that past tax liability and reap the benefits today.
You may want to start taking a closer look at these tax credits. You still have time to make certain investments this tax year to qualify for the credits. While I don't recommend that taxes should be the primary consideration behind an investment decision, understanding the tax effects of that decision can be helpful in calculating the proper return on investment. Projects that offer a marginal return could have a very different cost-benefit profile thanks to a tax credit.
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For more tips on planning for business growth, access our exclusive guide from LegalZoom CEO John Suh, Move Your Business Forward.
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