Business Tax Credit

Business tax credit is a tax provision that allows businesses to reduce their tax liability. It is allowed on the basis of encouraging companies to participate in certain positive activities deemed worthy of tax credit by the government. The reduction can be done on a dollar-to-dollar basis, which is different from a tax deduction.

Tax credits are introduced by the government and tax-collecting authorities to allow companies to operate and behave in a particular way. In the US, tax credits are offset by the Internal Revenue Service to the state or federal government. There is a whole process to claim the business tax credit, which includes certain forms and filing of documents.

A business tax credit is a provision established by tax legislation, not solely by the Internal Revenue Service (IRS). It enables firms to reduce their tax liability by a specified amount, either directly from their tax owed or as a refund if the credit exceeds their tax liability. While tax credits are often aimed at influencing certain behaviors or activities, they serve various purposes, such as stimulating economic growth, encouraging investment, or supporting specific industries. Eligibility for tax credits is subject to specific criteria outlined in tax laws, and not all businesses may qualify for every credit. Businesses can claim multiple tax credits based on their operations and adherence to eligibility requirements.

Tax credits are incentives provided by governments to encourage specific behaviors or activities by businesses. They directly reduce a company's tax liability by a specific dollar amount. There are various types of tax credits available to companies, including but not limited to work opportunity credits, investment credits, distilled spirit credits, and new markets credits. These credits are established by tax legislation and aim to achieve specific policy objectives, such as promoting economic development, supporting specific industries, or encouraging investment in particular areas.

The IRS can introduce new business tax credits. Hence, taxpayers and firms need to get assistance from tax professionals and chartered accountants to check eligibility for different types of business tax credits. If a company is eligible for both refundable and nonrefundable tax credits, it shall apply for the nonrefundable tax credits first.

On the official website of the Internal Revenue Service, there is a list of over 30+ business tax credits that can be taken advantage of if they meet the eligibility criteria; however, the business tax credits are categorized into three main types -

1. Refundable tax credit - These are paid out in full. In simple terms, irrespective of the taxpayer's tax liability or income, they are entitled to the entire credit amount unless it goes beyond the zero amount. So, if the taxpayer reduces the liability to below zero or negative, the taxpayer shall get a refund of the same amount.
2. Partially refundable tax credit - As the tax credit term suggests, in a partially refundable tax credit, the taxpayer only receives a portion of the difference back. An excellent example of this is the American Opportunity Tax Credit (AOTC).
3. Nonrefundable tax credit - Lastly, in a nonrefundable tax credit, a taxpayer can minimize a tax bill but cannot add or claim a refund. In case claiming puts the tax bill negative, it will be reduced to zero.

Below are some hypothetical and real world examples to understand the concept better.

Example #1

Suppose a corporation that builds batteries and other automobile parts files for its annual tax return but realizes that it can be eligible for Disabled Access Credit because they have installed facilities accessible to individuals and employees with disabilities.

The company takes the advice of a chartered accountant and files Form 3800; this is a general tax credit form used to tally the credits and calculate the total monetary amount.  Once verified, The credits can be claimed separately and are available on the IRS website. For disabled access, credit Form 8826 was filed.

If the company has a tax liability of $9900 but files a tax credit claim of $3600, the tax liability will be reduced by it.

Hence 9900 - 3600 = 6300

So after claiming the business tax credit, the corporation will not pay $9900 but $6300. It is a simple example of tax credit with companies, but in a real financial scenario, the filing and claim process has many considerations.

Example #2

According to a CNBC news article from September 2023, the IRS was planning to target unscrupulous tax preparers amid a crackdown on business tax credits. Just one year after Congress passed billions in IRS funding, the authority is planning to crack down on tax preparers with questionable practices.

The whole idea revolves around small business tax credits. Tax experts believe that preparers create issues for filers who may later face an IRS audit on future tax liability. IRS suggests that these preparers also need help from good tax preparers whom clients detest for complying with the tax regulations.

The main distinctions between business tax credits and business tax deductions are as follows:

• Business tax credits directly reduce the amount of tax owed, while business tax deductions lower taxable income.
• Business tax credits may require Form 3800 for certain credits, whereas business tax deductions may involve Schedule A Form 1040 or 1040 SR for itemized deductions, including some business-related ones. However, the specific forms needed can vary depending on the type of credit or deduction.
• Business tax credits can sometimes be applied on a dollar-for-dollar basis, meaning the credit amount directly reduces the tax liability. In contrast, business tax deductions may reduce taxable income by a percentage of eligible expenses or other factors rather than a direct dollar-for-dollar reduction.