Tax deductions are not nearly as important as tax credits. A credit, as opposed to a deduction, lowers a company’s tax obligation dollar for dollar. However, tax credits aren’t unlimited. The general business credit (GBC), which is located in Internal Revenue Code Section 38, may have a maximum limit on the total amount of tax credits for businesses. In order to identify tax savings and to understand the value of their business credits, taxpayers should become acquainted with the GBC.
How the General Business Credit Works
In the traditional sense, the GBC is not a tax credit. Instead, it’s a collection of several dozen business-related credits spread throughout the tax law. It is necessary to claim each credit separately, utilizing the appropriate tax forms and adhering to regulations. However, in order to determine the total permissible credit under the GBC and to report the cumulative value of all the credits claimed, taxpayers who make multiple credit claims also need to complete Form 3800.
The General Business Credit caps the total credits in a given year to the excess (if any) of the net income tax of the taxpayer over the higher of:
- The annual tentative alternative minimum tax, or
- Twenty-five percent of the amount by which the taxpayer’s net regular tax liability exceeds $25,000.
For the purposes of calculating the GBC, “net income tax” is defined as the total of the taxpayer’s regular tax liability and AMT liabilities, less certain non-GBC credits. The term “net regular tax liability” refers to the regular tax liability less certain credits.
In essence, the GBC limit stops taxpayers from utilizing credits to circumvent AMT. Because the corporate AMT was eliminated by the Tax Cuts and Jobs Act (TCJA), it hasn’t been a problem for C corporations in recent years. The GBC is mostly unaffected by the newly passed Inflation Reduction Act, despite the fact that it created a new corporate minimum tax on businesses with “book profits” over $1 billion for tax years starting after December 31, 2022.
Although the TCJA significantly raised the AMT exemption and made other modifications that result in fewer taxpayers being subject to it, the AMT for individuals still exists. However, AMT may still restrict how individual taxpayers—such as shareholders in S corporations, sole proprietors, and partners—use the GBC.
What Does the GBC Cover?
More than thirty separate tax credits make up the general business credit (GBC), which offers incentives for a range of business activities. Some instances are:
- Alcohol fuels credit,
- Disabled access credit,
- Credit for employer Social Security and Medicare taxes paid on certain employee tips,
- Credit for small employer pension plan startup costs,
- Employer credit for paid family and medical leave,
- Employer-provided child care facilities and services credit,
- Empowerment zone employment credit,
- Investment credit,
- Low-income housing credit,
- New energy-efficient home credit,
- Orphan drug credit,
- Renewable electricity production credit,
- Research credit,
- Small employer health insurance credit,
- Work Opportunity credit, and
- A portion of the credits are for alternative motor vehicles, alternative fuel vehicle refueling property and new qualified plug-in electric drive motor vehicles.
How to handle unused credits
If a taxpayer is unable to utilize the entire General Businss Credit due to constraints, any unused credit can be carried forward for a maximum of 20 years after being carried back for a year. The GBC is used in the following order in any given year:
- Carryforwards to that year, starting with the oldest ones,
- GBC earned in that year, and
- The carryback to that year.
By effectively using a first-in, first-out (FIFO) strategy, these ordering rules reduce the chance that unused credits would expire. Nevertheless, taxpayers who have a significant excess of credits run the risk of losing credits that aren’t used over the 20-year carryforward period. Thankfully, there is some assistance available to people in this situation.
Deduction of unutilized credits
The tax code generally forbids taxpayers from “double-dipping” by preventing them from claiming a tax credit and a tax deduction for the same expenses. As a result, taxpayers usually have to classify a portion of their expenses (up to the credit amount) as nondeductible in the year that a General Business Credit is earned.
In many cases, when a credit is lost, Section 196 allows the lost credit amount to be claimed as a deduction. Should the credit be forfeited due to the expiration of the 20-year carryforward period, the taxpayer has the option to claim the deduction in the subsequent tax year. If it’s lost because the taxpayer dies or ceases to exist, the deduction may be claimed for the year of death or cessation.
For C corporations thinking about selling, the Sec. 196 deduction can offer a chance to save money on taxes. Purchasing stock in a corporation and then electing to have the transaction treated as a deemed asset sale for tax purposes is a typical practice. However, the seller may see large taxable gains as a result. The seller may be able to make a Sec. 196 deduction to offset all or part of the gains if it has a sizable amount of unused GBCs (because the selling corporation ceases to exist).
Get the credit you are due
It can be difficult to determine the General Business Credits for a particular year and to calculate the appropriate limitations. To take full advantage of these worthwhile credits, make sure you collaborate with one of our Landmark tax experts.