Tax credits are a dollar-for-dollar reduction of taxes owed. Some credits offset income taxes; others offset employment taxes. Some credits are part of the general business credit and subject to an annual limitation; others are fully refundable (they can be recouped in excess of what taxes are owed). For pass-through entities, the business must qualify for the credit, but owners claim their share on their personal returns. In some cases, limitations apply at both the entity and owner levels. If all of this sounds complicated, that’s because it is…and you need to work with a tax professional. The following will help you ask the right questions.
To help you ask the right questions, here’s what you need to know:
Tax credit refunds in general
Income tax credits for businesses are part of the general business credit which is not a separate credit but a limitation on total credits. So, first you figure individual credits that are part of the general business credit, such as the work opportunity credit and the research credit (below) and then you apply the general business credit limitation. In general terms, this is net income tax minus the greater of 25% of regular tax liability over $25,000, or 75% of the tentative minimum tax (something that applies to owners of pass-through entities and certain large C corporations after 2022).
If total credits exceed the limitation, the excess is carried back one year and is subject to the limitation for that year. You can’t waive this carryback; it’s claimed on an amended income tax return or file for a quick (tentative) refund. Still have credits in excess of the limitation? There’s a 20-year carryforward.
Research credit refunds
To obtain an income tax refund from the research credit, you must provide “five items of information”:
- Identify all the business components to which the research credit claim relates for that year.
- For each business component, identify all research activities performed and
- Name the individuals who performed each research activity,
- As well as the information each individual sought to discover.
- Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year. This may be done using Form 6765, Credit for Increasing Research Activities.
Faulty refund claim. If you submit a refund claim but don’t include all required information, the IRS gives you 45 days to “perfect” your claim. The IRS likes missing information to be faxed to them at the number provided in the notice requesting the missing information. The 45-day grace period runs only to January 10, 2024. After that, you better get it right the first time.
Employee retention credit refunds
The employee retention credit (ERC) is a refundable employment tax credit meant for businesses who continued paying employees while shut down due to COVID-19 or had significant declines in gross receipts from March 13, 2020, to December 31, 2021. Eligible taxpayers can claim the ERC on an original or amended employment tax return for a period within those dates, and an unspecified number of businesses have done so.
Many businesses are still waiting for their funds. And some may never obtain them because they were erroneously claimed. There have been third parties that charged large upfront fees or fees contingent on the amount of a refund that advised businesses to take improper positions (e.g., the business wasn’t eligible or incorrectly figured the credit). The IRS warned businesses of these spurious claims.
The list of credits has been expanding year by year as Congress incentivizes certain actions. For example, starting next year, there’s a new credit for commercial clean vehicles. Check which credits you may qualify for now. If you’ve overlooked any and your time for filing an amended return hasn’t expired, submit a refund claim. Work with your CPA or other tax adviser to determine the best course of action for your situation.