Section 39: Rules for Unused Business Credits

Businesses often earn tax credits for certain activities, but they may not be able to use the full value of these credits in the year they are earned. This situation creates an “unused” credit. The Internal Revenue Code provides a specific set of rules to govern what happens next. Section 39 of the code establishes the framework that allows businesses to carry these excess credits to other tax years, ensuring they are not lost.

The General Business Credit Context

The rules outlined in Section 39 apply to a broad category of credits known as the General Business Credit, or GBC. The GBC is defined under Internal Revenue Code Section 38 and is not a single credit, but a combination of many individual business-related tax credits. This structure groups numerous separate credits under a uniform set of rules for limitations and carryovers. A business calculates each specific credit on its own designated form before aggregating them.

Common examples of credits that fall under the GBC include the Work Opportunity Credit, the Investment Credit, and the Credit for Small Employer Health Insurance Premiums. After calculating these individual amounts, they are totaled on Form 3800, General Business Credit. The total GBC a business can claim in a single year is limited by its tax liability. This limitation often results in a portion of the credit going unused in the current tax year.

Applying Carryback and Carryforward Rules

Section 39 dictates a specific timeline for using excess credits from the GBC. Generally, an unused credit is first carried back one year, although exceptions exist for certain credits which may have different carryback periods. If the credit is not fully used in the carryback period, it can then be carried forward for up to 20 years.

An option called “elective payment” or “direct pay” is available for certain credits, primarily those related to clean energy and manufacturing. This provision allows eligible taxpayers, including tax-exempt organizations, to receive a direct cash refund from the IRS for the credit amount, even if they have little or no tax liability. This offers a way to immediately monetize these specific credits rather than carrying them to other tax years.

The application of carried-over credits follows an ordering rule known as First-In, First-Out, or FIFO. Credits carried forward from the earliest years must be used first before any credits from more recent years can be applied. For example, if a company has an unused credit from 2023 and another from 2024, it must fully apply the 2023 carryforward before it can begin to use the carryforward from 2024.

After applying all carryforwards, the business then applies the credits earned in the current year, followed by any carrybacks. If a credit remains unused after the 20-year carryforward period, it expires. However, a business may be able to take a tax deduction for the amount of the expired credit in the year following its expiration.

How to Claim Unused Credits

The procedure for claiming an unused credit depends on whether it is being carried back to a prior year or forward to a future one. To claim a carryback, a business must amend the tax return for the specific prior year to which the credit is being applied. This requires filing a specific form, such as Form 1040-X for individuals or Form 1120X for corporations. Along with the amended return, a revised Form 3800 for that prior year must be included.

Claiming a carryforward is integrated into the current year’s tax filing. The unused credit amount from a prior year is reported on the appropriate line of the current year’s Form 3800. No amendment of a prior return is necessary for a carryforward.

For both processes, record-keeping is important. A business must maintain clear records that track the original amount of the credit, the year it was earned, and how much of it has been used in subsequent years. This documentation is necessary to accurately report the available carryforward amount on Form 3800 each year and to substantiate the claims in the event of an IRS inquiry.