Business Tax Credits

What Are Business Tax Credits?

Business tax credits are an amount that companies can subtract from the taxes owed to a government. Business tax credits are applied against the taxes owed, as opposed to a deduction that is used to reduce taxable income. Businesses apply the tax credits when they file their annual tax return. In the United States, the Internal Revenue Service (IRS) oversees the application of business tax credits as the credits are used to offset a company’s financial obligation to the federal government.

Understanding Business Tax Credits

Business tax credit is a generic way of referring to tax credits aimed at spurring a particular type of corporate action. Business tax credits can come in many forms, but some of the common business tax credits are aimed at activities like hiring employees who face barriers to employment, investing in research, upgrading a building to be more efficient, and so on. The fact that a business tax credit exists for an activity means that the government is seeking to reward and encourage that activity.

Unlike an allowable deduction, business tax credits are targeted. This is because they represent more of a tax reduction opportunity for businesses, which corresponds directly with less tax revenue for the government. It is in the best interests of a business to use all credits that it is qualified for to reduce the amount of money owed the federal government come tax time.

Key Takeaways

  • Business tax credits are designed by the government to encourage a particular type of corporate behavior.
  • Business tax credits provide companies with a direct reduction in tax liability in return for taking a particular action.
  • Many business tax credits are broad in application, supporting things like worker pensions and employment opportunities for groups facing barriers to employment.
  • Governments also target tax credits at particular industries to support continued expansion.

In addition to their value to businesses in reducing taxes in a current filing year, business tax credits often come with some flexibility as far as applying them to past and future returns. If a business has exceeded their tax credits for the current tax year, but not the prior year, they may be able to carry those credits backwards and apply them to the tax returns that they have already filed. In the same vein, if they have more credits than are permitted in the current tax year, they may carry the balance of those credits into the next tax year. This is called a carryforward.

Business Tax Credits Versus Business Tax Deductions

Business tax credits tend to be used sparingly by governments because they are such a powerful incentive. As such, people often confuse them with the more commonly known business tax deductions. The main difference between a business tax credit and a business tax deduction is that tax deductions are used to reduce the taxable income whereas a tax credit directly reduces the tax liability. This means a business tax deduction of $5,000, for example, will only save the business a percentage of that $5,000. If a corporation is in a 20% tax bracket, then the $5,000 deduction is only worth $1,000 in reduced taxes. If the corporation qualifies for a $5,000 tax credit, however, they benefit from the full $5,000 in reduced taxes.

Business Tax Credits in the United States

In the United States, there are a number of business tax credits and they often carry their intended purpose in the title. The Indian Employment Credit, for example, gives a tax credit to employers who hire Native Americans. Companies can also claim business tax credits clearly targeted at particular industries and sectors, like the Biofuel Producer Credit and the Orphan Drug Credit.

When filing, the General Business Tax Credit Form 3800 is used to tally up many of the separate tax credits for the purpose of determining the overall allowable credit. These credits must still be claimed individually using the specific form that can be found on the IRS website, or by consulting with an accountant or licensed tax professional. The available credits, as well as their applicable forms, may change from year to year, so it is important to consult with the IRS website before filing.

Example of How Companies Use Business Tax Credits

Imagine ABC Corporation is in the process of filing their annual tax return. They are going through the list of available tax credits and have realized that they may claim the Credit for Employer-Provided Child Care Facilities and Services, since they have an on-site daycare. Using Form 8882, they list this credit. However, the amount of money that they are claiming is higher than this year’s allowable amount. Since this tax year was the first year they provided on-site daycare services, they can retroactively apply a portion of the credit to the prior tax year.

However, ABC Corporation is not done, and they have discovered that they are also able to claim some additional tax credits. Since they have maxed out their credits for this year, they will apply the remainder of those credits to the following tax year. With all the available business tax credits they were able to take this year, ABC Corporation owed a much smaller amount to the government this year. Next year, they will already have several credits to apply to their remaining obligation, even if they don’t have any new tax credits to claim.

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  1. Internal Revenue Service. "Instructions for Form 3800," Page 2. Accessed Jan. 21, 2021.

  2. Internal Revenue Service. "Instructions for Form 3800," Page 1. Accessed Jan. 21, 2021.

  3. Internal Revenue Service. "Instructions for Form 3800," Pages 1 and 2. Accessed Jan. 21, 2021.

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