Once you've decided that one or more of the available tax credits apply to you, how do you go about claiming it? The easiest answer is, you don't you leave it up to your tax pro, because the rules for most credits are too complicated for the average small business owner to handle.
However, we're including the basic concepts here, so that you can ask intelligent questions of your accountant or lawyer, and see that he or she is earning the fees that you pay. You can also use this information as a starting point if you are a stouthearted do-it-yourselfer.
There are a number of steps you must take in the process of computing and claiming your tax credits:
- First, compute your regular tax liability. Before you can determine the amount of your credits, you need to know what your income is for the year, subtract all your allowable deductions, and compute your tax liability on that basis (as if you had no credits). If you're a sole proprietor, part of the process will be completing Schedule C, Profit or Loss From Business, so you can determine your net income for your business. If the credit was earned by a corporation, compute the corporation's regular tax liability. If the credit was earned by a business organized as a partnership (or some entity taxed as a partnership, such as an LLC), the credits will be computed at the business entity level, and then passed through to the partners or members.
- Second, compute your alternative minimum tax liability, if any. Generally, credits cannot be claimed to the extent that they would reduce your tax bill below your tentative minimum tax.
- Third, compute your nonrefundable credits and subtract them in the prescribed order. The order is important because each credit is limited to the amount of the tax minus the credits previously taken. Claim credits in the following order:
- personal nonrefundable credits, such as the credit for child and dependent care, the credit for the elderly and disabled, the adoption credit, the child credit, education credits, and the credits for interest on certain home mortgages
- the foreign tax credit
- the alternative fuels credit
- the general business credit, which is made up of the following parts:
- the investment tax credit (which includes the rehabilitation credit, the energy credit, the qualifying advance coal project credit, the qualifying gasification project credit, the qualifying advanced energy project credit, and the qualifying therapeutic discovery credit);
- the work opportunity credit;
- the alcohol fuels credit;
- the credit for increasing research activities;
- the low-income housing credit;
- the enhanced oil recovery credit;
- the disabled access credit for expenditures paid or incurred by an eligible small business;
- the renewable resources electricity production credit;
- the Indian employment credit;
- the employer social security (FICA tip) credit;
- the orphan drug credit;
- the new markets tax credit;
- the small employer pension plan startup costs credit;
- the employer-provided child care credit;
- the biodiesel fuels credit;
- low sulfur diesel fuel production credit;
- the railroad track maintenance credit;
- the distilled spirits credit;
- the advanced nuclear power facility production credit;
- the nonconventional source production;
- the new energy efficient home credit;
- the portion of the alternative motor vehicle credit attributable to depreciable property;
- the portion of the alternative fuel vehicle refueling property credit attributable to depreciable property;
- the Hurricane Katrina housing credit;
- the Hurricane Katrina employee retention credit;
- the Hurricane Rita employee retention credit;
- the Hurricane Wilma employee retention credit;
- the mine rescue team training credit;
- the agricultural chemicals security credit;
- employer wage credit for employees who are active duty members of the uniformed services;
- the carbon dioxide sequestration credit;
- the portion of the new qualified plug-in electric drive motor vehicle credit attributable to depreciable property;
- and the small employer health insurance credit.
- Fourth, compute any carryback or carryover amounts. If you can not fully use the credit in 2011, you may have a carryover amount.
- Finally, compute and subtract your refundable credits from your remaining tax liability, if any. Refundable credits include the earned income credit, affordable education credit, credit for any income taxes withheld on your paycheck, and the credit for gasoline and special fuels taxes. If subtracting these credits leaves you with a tax liability below zero, the IRS will send you a check for the difference.
Dollar limitations on credits. In most cases, the limit on the credits you can claim for the year is computed as follows: take your regular tax liability, subtract your tentative minimum tax liability, and the result is the dollar limit on credits you can claim for the year. The credits are subtracted in a prescribed order, and some, including components of the general business credit, as well as the general business credit itself, have additional limits that must be observed.
Forms to use. Most of the credits must be computed on their own special IRS forms. In addition, if you are claiming more than one of the components of the general business credits, if you have a carryback or carryover, or a credit from a passive activity, you will also need Form 3800, General Business Credit, to compute any limitations on the combined credit components.