Business Tax Credits: Meaning, How They Work, Example (2024)

What Are Business Tax Credits?

Business tax credits reduce a business' tax liability. These tax credits are offered to businesses as a result of specific business activities they undertake. Tax credits reduce the amount of taxes owed and are different than tax deductions. Tax deductions reduce the amount of your income before you calculate the tax you owe.

In the U.S., tax credits offset a company's financial obligation to the state or federal government; the Internal Revenue Service (IRS) oversees the application of business tax credits.

Understanding Business Tax Credits

There are many types of business tax credits; some common ones reward companies for investing resources in research, upgrading systems to operate more efficiently, and hiring employees who face barriers to employment. Governments offer tax credits for different reasons, including spurring particular types of corporate action and supporting the expansion of particular industries.

Business tax credits reduce the amount of taxes that a business owes to the government. In general, businesses pursue opportunities that make them eligible for business tax credits because their total amount of taxes owed is reduced as a result.

Sometimes there is flexibility in terms of the tax year that business tax credits are applied. For example, if a business has exceeded its tax credits for the current tax year, but not the previous tax year, it may be able to apply those credits retroactively to a previous year's tax return. Alternatively, the business may be able to apply eligible tax credits to a future tax return. (This action is called a carryforward.)

Businesses calculate their tax credits when they file their annual tax return. Form 3800: General Business Credit is an IRS form used to tally up separate tax credits and to determine the overall credit amount. Then, the credits are claimed separately using the individual forms applicable to that tax credit. These forms can be found on the IRS website. Available credits, as well as their applicable forms, may change from year to year; for this reason, it's important to consult the IRS website—or an accountant or licensed tax professional—before filing.

Business Tax Credits in the U.S.

In the United States, there are many business tax credits. For example, employers who hire Native Americans may be eligible for the Indian Employment Credit (IEC). Companies working in certain sectors may be eligible for specific tax credits aimed at bolstering those industries.

Companies that sell or use alcohol fuels (or alcohol fuel mixtures) produced in the United States—and used as a fuel in the United States—may be eligible for the Biofuel Producer Credit. The Orphan Drug Credit incentivizes the pharmaceutical industry to engage in business activities that may lead to treatments for rare diseases, including qualified clinical trials.

Business Tax Credits vs. Business Tax Deductions

The main difference between a business tax credit and a business tax deduction is that tax deductions are used to reduce total taxable income, whereas a tax credit reduces the total taxes owed, or tax liability.

For example, a business tax deduction of $5,000 saves a business a percentage of that $5,000; if that corporation is in a 20% tax bracket, the $5,000 deduction is worth $1,000 in reduced taxes. ($5,000 * 20% = $1,000.) If the corporation qualifies for a $5,000 tax credit, however, it benefits from the full $5,000 in reduced taxes.

Example of a Business Tax Credit

ABC Corporation is in the process of filing its annual tax return. The business is going through the list of business tax credits and realizes it may be eligible for the Employer-Provided Childcare Facilities and Services credit because the company has an on-site daycare center.

When the company files its tax return, it includes Form 8882: Credit for Employer-Provided Childcare Facilities and Services. However, the amount of money the company is claiming is higher than this year’s allowable tax credit amount. Because it didn't claim this tax credit for its daycare center in the previous year, it can retroactively apply a portion of the credit to the prior tax year.

How Do Tax Credits Work?

A tax credit reduces the money owed to the government in a given tax year. Each tax credit is a specific dollar amount; that dollar amount directly reduces the dollar amount of taxes owed. Unlike a tax deduction, which reduces the total amount of taxable income, a tax credit directly reduces the amount of taxes owed. For example, if a business qualifies for a tax credit of $1,000, that tax credit would directly lower the business' tax bill by $1,000.

What Is a Business Tax Credit?

A business tax credit reduces the amount of tax owed by a business. Depending on the type, tax credits are different dollar amounts. When filing its annual tax return, a business eligible for a specific tax credit must file a separate form. Provided the business meets the eligibility requirements for the tax credit, it receives a dollar-for-dollar reduction of its annual tax liability.

Who Qualifies for the ERC Tax Credit?

The Employee Retention Credit (ERC)—also called the Employee Retention Tax Credit (ERTC)—was a tax credit for businesses and tax-exempt organizations during the COVID-19 pandemic. The ERC tax credit is no longer available for businesses to claim; the passage of the Infrastructure Investment and Jobs Act (IIJA), signed on Nov. 15, 2021, eliminated the ERC for most businesses after Sept. 30, 2021.

The Bottom Line

Business tax credits arean amount of money that companies can subtract from the taxes owed to a government. Business tax credits are applied against the taxes owed, as opposed to a deduction that is used to reduce taxable income. Businesses apply the tax credits when they file their annual tax return.