Rather than reducing taxable income, business tax credits are applied against the taxes owed by businesses. As opposed to deductions that are used to reduce taxable income, business tax credits are applied against the taxes owed by businesses. Businesses are required to apply the credits when they file their annual tax returns. Since business tax credits are used to offset the federal government’s financial obligations, the Internal Revenue Service (IRS) oversees the application of these credits.
Business Tax Credits: An Overview
Corporate tax credits serve as a generic way of referring to tax credits that encourage particular types of corporate activity. Tax credits for businesses come in many forms, but many are focused on activities such as hiring people with disabilities, investing in research, upgrading a building to make it more efficient, etc. As a result of the presence of a business tax credit, the government is seeking to reward and encourage the activity.
Since they represent more of a tax reduction opportunity for businesses, business tax credits are targeted, rather than an allowable deduction. As a result, the government receives less tax revenue. To reduce the amount of taxes owed by a business, it is in its best interest to apply for all of the credits it qualifies for.
What You Need To Know
- In order to encourage a particular type of behavior among corporations, the government issues tax credits to businesses.
- In return for taking a particular action, businesses can receive a tax credit that reduces their tax liability.
- Many business tax credits support a variety of needs, including employee pensions and employment opportunities for groups facing employment barriers.
- To encourage continued expansion, governments also offer tax credits to specific industries.
It is common for business tax credits to come with some flexibility as far as applying them to past and future returns, in addition to the benefit they provide businesses in reducing their tax liability in a current filing year. If a business has exceeded its tax credits for the current tax year, but not for the prior year, it may be able to carry those credits backwards and apply them to the tax returns that it has already filed.
The difference between business tax credits and business tax deductions
Governments tend to use business tax credits sparingly due to their powerful incentives, which makes people confuse them with business tax deductions, which are more commonly known to most people. A business tax credit differs from a business tax deduction primarily in that a deduction reduces taxable income whereas a credit reduces the tax liability directly. If a corporation is in a 20% tax bracket, the $5,000 deduction will only be worth $1,000 in reduced taxes. So a $5,000 business tax deduction, for instance, will only save a percentage of that $5,000. Corporations that qualify for a $5,000 tax credit, however, will benefit from the full $5,000 in reduced taxes.
In the United States, business tax credits are available
Businesses can take advantage of a variety of business tax credits in the United States, many of which are named after their intended purpose. For example, the Indian Employment Credit provides employers who hire Native Americans with a tax credit. Businesses can also claim business tax credits clearly targeted at particular industries and sectors, such as the Biofuel Producer Credit and the Orphan Drug Credit.
A general business tax credit form 3800 is used to determine the total allowable credit by adding up many different tax credits. It is still necessary to claim these credits individually using the specific form available on the IRS website, or by consulting with an accountant or tax professional. It is important to consult with the IRS website before filing, since the available credits may change from year to year.
A company’s use of business tax credits
In the process of filing their annual tax return, ABC Corporation thinks about what to do. While reviewing the list of tax credits available to them, they realize that they may qualify for the Employer-Provided Child Care Facilities and Services Credit, as their daycare is located on-site. The amount claimed by them is higher than the amount allowed by the IRS this year on Form 8882.
In addition to claiming some additional tax credits, ABC Corporation found out that they were not done yet. As they have maxed out their credits for the year, the remaining credits will be applied to the next. Due to all the business tax credits ABC Corporation was able to take this year, they owed the government a much smaller amount. They will already have some credits available next year to reduce their remaining liabilities, even