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Business Tax Credits

Tax credits are allowed as an offset to an individual?s net regular tax. However, credits generally cannot reduce regular tax liability below the alternative minimum tax (AMT). The credits discussed in this chapter arise from business activities either conducted directly by the taxpayer (e.g., sole proprietorships) or through pass-through entities (e.g., partnerships or S corporations). If the activity giving rise to the credit is a passive activity the credit may offset current tax only to the extent the tax is attributable to net passive activity income. Credits limited because of the passive activity rules carry over indefinitely.

The more common business credits are combined into the ?general business credit? (GBC). This credit may offset a limited amount of net regular tax. Any such credit arising in the years beginning after 1997 and unused because of this limit generally can be carried back one year and forward 20 years. Unused credits that arise in tax years before 1998 are still subject to the prior 3-year carryback and 15-year carryforward rules. The amount of GBC that can be claimed is also limited by the at-risk rules.

Another common business credit is the nonconventional source fuel credit. This credit is not one of the credits comprising the GBC. It is not subject to the at-risk rules but may be subject to the passive activity rules. (Reference Rev. Rul. 91-38, 1991-2 CB 3).

Commonly Encountered Business Credits

The Internal Revenue Code already allows business tax credits for various purposes, which reduce Federal Income Tax Liability. A multitude of business income tax credits are combined into the general business credit (GBC). The following are the more common credits that are part of the GBC.

  1. Work Opportunity Tax Credit (The Landscaper & General Contractor?s Friend - The Section 51 work opportunity tax credit is available to employers of persons who fall into one of the designated targeted groups (generally, economically or physically disadvantaged persons) who began work after September 30, 1996 and before January 1, 2002. (Congress extended the credit from July 1, 1999 to December 31, 2001). An employee must submit Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity and Welfare-to-Work Credits) to the employer showing how the employee falls into one of the groups. Call us for a Quick Reference Table that summarizes the rules for this credit.

  2. Low Income Housing Credit: The Section 42 low-income housing credit is available to owners of new or substantially rehabilitated residential property rented to low-income persons. The credit is claimed on Form 8586 (Low-Income Housing Credit).

  3. Fuel Credit: Another common credit is the Section 29 nonconventional source fuel credit. This credit is allowed on the sale of domestically produced qualified fuels derived from nonconventional sources and is claimed directly on line 48 of page 2 of Form 1040 (with ?FNS? entered on the dotted line). The FNS credit is not one of the credits comprising the GBC.

  4. Rehabilitation Investment Credit: The Section 47 rehabilitation investment credit is available to owners of rehabilitated older buildings used for nonresidential purposes or certified historic structures used for residential or nonresidential purposes. The credit is claimed on Form 3468 (Investment Credit).

  5. Disabled Access Credit: The Section 44 disabled access credit is available to eligible small businesses that make improvements to facilitate the access and use of the business facilities by disabled individuals. The credit is claimed on Form 8826 (Disabled Access Credit).

    TAX TIP: When analyzing business expenses businesses should pay particular attention to remodeling expenditures. Those that qualify for this credit are often overlooked.

  6. Incremental Research Credit: The Section 41 incremental research credit is available for increasing qualified research expenditures. The credit is claimed on Form 6765 (Credit for Increasing Research Activities).

    TAX UPDATE: The research and experimentation credit expired on June 30, 1999. Congress retroactively extended the credit through June 30, 2004, subject to two suspension periods. Research credit expenditures for the period July 1, 1999 through September 30, 2000 may not be taken into account before October 1, 2000. Also, research credit expenditures for the period October 1, 2000 through September 30, 2001 may not be taken into account until October 1, 2001.

  7. Enhanced Oil Recovery Credit: The Section 43 enhanced oil recovery credit is available to owners of operating mineral interests that use certain tertiary methods to significantly increase the amount of oil recovered. The credit is claimed on Form 8830 (Enhanced Oil Recovery Credit).

  8. Employer Social Security Credit: (The Restaurant-Employer?s Friend) The Section 45B employer social security credit is available to food and beverage establishments for social security taxes paid on tip income in excess of minimum wages. The credit is claimed on Form 8846 (Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips).

  9. Empowerment Zone Employment Credit: The Section 1396 empowerment zone employment credit is available to business owners employing individuals who are residents of an empowerment zone. The credit is claimed on Form 8844 (Empowerment Zone Employment Credit).

  10. Welfare-to-Work Credit: The Section 51A welfare-to-work credit is effective for wages paid to workers who begin work after 1997 but before January 1, 2002. (Congress extended the credit from July 1, 1999 to December 31, 2001). The credit is available for the first $10,000 of wages paid to employees who are ?long-term family assistance recipients.? The credit is claimed on Form 8861 (Welfare-to-Work Credit). A worker for whom the welfare-to-work credit is claimed is not treated as a member of a targeted group for purposes of the work opportunity credit. You can call us for the rules that summarizes the rules for this credit. The maximum size of this credit is $2,400.

    The GBC generally is applied dollar for dollar against the first $25,000 of net tax liability (generally, regular tax less personal credits) and against 75% of the remaining net tax liability [IRC Sec. 38(c)]. Additional limits may apply if the taxpayer has significant AMT adjustments and preferences, even if the AMT does not apply. (See Key Issue 36B.)

    Unused GBCs arising in 1998 and subsequent tax years generally can be carried back one year and forward 20 years [IRC Sec. 39(a)(1)]. For credits arising in tax years before 1998, the carryback period is three years and the carryforward period is 15 years.

    Any unused work opportunity credit, welfare-to-work credit, rehabilitation investment credit, incremental research credit, empowerment zone employment credit, or enhanced oil recovery credit remaining at the end of the carryover period, or at the taxpayer?s death, is deductible in the following year or, in the case of the taxpayer?s death, on the taxpayer?s final return (IRC Sec. 196). The deduction for unused research credits arising before 1990 is limited to 50% of such credits [IRC Sec. 196(d)(2)].

    TAX ALERT: Neither the Code, regulations, IRS publications, nor instructions to Form 3800 (General Business Credit) identify where to deduct the unused credit. DeHoff & DeHoff suggest it should appear on the schedule reporting the activity generating the credit (e.g., Schedule C, E, or F).

    The amount of the GBC that can be claimed also may be limited by the application of the at-risk and passive activity rules. Special limitation and reporting rules, as detailed in the summary tables in the Quick Reference Binder, apply if the credit is passed through to the taxpayer from a partnership or an S corporation. TAX TIP: GBCs initially are reported on the appropriate form for each credit [such as Form 5884 (Work Opportunity Credit)]. However, if a taxpayer claims more than one of these credits, reports a carryback or carryforward of a credit, or has credits from a passive activity the amounts from the individual credit forms flow (with the exception of the empowerment zone employment credit) to Form 3800, which summarize all GBCs. The individual credit forms and Form 3800, if applicable, are filed with the taxpayer?s return.

    Businesses that hired employees from targeted groups may receive the Work Opportunity Tax Credit for the employees' first year of work. If you hired "target" employees between October 1, 1997 and June 30, 1999, you can receive a 40% credit for the first $6,000 paid to each employee.

    The targeted groups include: Aid to Families with Dependent Children recipients, veterans, ex-felons, high-risk youth, vocational rehabilitation referrals, summer youth employees (special limitations apply), food stamp recipients, and supplemental security income recipients.

    Last year, Congress breathed new life into the Research and Development (R&D) tax credit, extending the credit to June 30, 1999. The credit is available for 20% of your increased research expenses which you paid or incurred between July 1, 1996 and June 30, 1999. In addition, 75% of payments to nonprofit research groups can qualify for the credit. As important as R&D is to the health of American industry, Congress may reinstate this tax credit again after it expires in June. Contact us to determine its current status. As with all tax credits, be aware of the impact of the AMT, which can substantially diminish these credits.

    Return to Business Tax Planning


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