Tax credits are far more valuable than tax deductions. Unlike a deduction, which reduces a business’s taxable income, a credit reduces the business’s tax liability dollar for dollar. Tax credits aren’t unlimited, however. For businesses, the aggregate value of tax credits may be limited by the general business credit (GBC), found in Internal Revenue Code Section 38. Taxpayers should familiarize themselves with the GBC so they can understand the value of their business credits and identify tax-saving opportunities.
How It Works
The GBC isn’t a tax credit in the usual sense. Rather, it’s a collection of dozens of business-related credits scattered throughout the tax code. (See “What’s included in the GBC?” in the right-hand box.) Each credit must be claimed separately, according to its specific rules and using the relevant tax forms. Taxpayers that claim more than one credit, however, must also file Form 3800 to report the aggregate value of those credits and calculate the overall allowable credit under the GBC.
The GBC limits total credits in a given year to the excess (if any) of a taxpayer’s net income tax over the greater of:
The tentative alternative minimum tax (AMT) for the year, or
25% of the amount by which the taxpayer’s net regular tax liability exceeds $25,000.
For purposes of calculating the GBC, “net income tax” is the sum of the taxpayer’s regular tax liability and AMT liability, reduced by certain non-GBC credits. “Net regular tax liability” is regular tax liability reduced by certain credits.
The GBC limit essentially prevents taxpayers from using credits to avoid AMT. In recent years, that hasn’t been an issue for C corporations, because the corporate AMT has been permanently repealed for most companies. Although the Inflation Reduction Act of 2022 established a new corporate minimum tax for corporations with “book profits” over $1 billion for tax years beginning after December 31, 2022, it generally doesn’t limit the GBC. For individual taxpayers — such as sole proprietors, partners and S corporation shareholders — AMT may limit their use of the GBC.
Treatment of Unused Credits
You must use your GBC on a “first-in, first-out basis,” by offsetting the earliest-earned credits first. Thus, your credit for a tax year consists of your carryforward of business credits from prior years plus the total of your current year business credits. Your credit for the year may later be increased by the carryback of business credits from subsequent years.
The GBC is generally nonrefundable. That means it can reduce your tax liability only to zero.
Unused credits can typically be carried back one year. Unused credits remaining after a one-year carryback can be carried forward for 20 years. Qualified business credits that remain unused after the last tax year of the 20-year carryforward period can be taken in full as a tax deduction. You’ll generally claim the deduction in the tax year following the last tax year of the carryforward period.
Important: Certain credits are subject to different carryback rules. For example, beginning with the 2023 tax year, energy-related tax credits eligible for elective payments or transfers under Internal Revenue Code Section 6417 can be carried back three years and then forward 20 years. And certain oil and gas production credits can be carried back five tax years.
Deduction for Unused Credits
To prevent taxpayers from “double-dipping,” the tax code generally doesn’t permit them to claim a tax credit and a tax deduction based on the same expenses. Thus, in the year that a GBC is generated, taxpayers generally must treat a portion of its expenses (equal to the amount of the credit) as nondeductible.
In many cases, when a credit is lost, Section 196 allows the lost credit amount to be claimed as a deduction. If the credit is lost because the 20-year carryforward period expires, the taxpayer may claim the deduction in the following 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.
The Sec. 196 deduction may provide a tax-saving opportunity for C corporations contemplating a sale. It’s common for buyers to acquire a company’s stock and then make an election to treat the transaction as a deemed asset sale for tax purposes. But this can trigger substantial taxable gains for the seller. If the seller has significant unused GBCs, it may be able to use a Sec. 196 deduction to offset some or all of those gains (because the selling corporation ceases to exist).
Secure the Credits You Deserve
Determining GBCs for a given year, and calculating applicable limits, can be complicated. Be sure to work with your tax advisor to make the most of these valuable credits.
What’s Included in the GBC?
The general business credit (GBC) consists of dozens of business-related tax credits that provide incentives for a variety of business activities. Examples include:
- Research and experimentation credit,
- Disabled access credit,
- Employer-provided child care facilities credit,
- Small employer health insurance credit,
- Credit for small employer pension plan startup costs,
- Employer credit for paid family and medical leave,
- Employer credit for Social Security and Medicare taxes paid on certain employee tips,
- Low-income housing credit,
- New markets credit, and
- Orphan drug credit.
Many energy-related and manufacturing credits are also part of the GBC. Contact your tax advisor for a complete list of credits that must be reported on Form 3800.