Section 46: The General Business Credit Explained
Understand the framework of the General Business Credit under Section 46 and how it aggregates various tax incentives to lower a business's tax liability.
Section 46 of the Internal Revenue Code establishes the framework for the General Business Credit (GBC). This credit is not a singular deduction but an umbrella term that consolidates numerous individual business-related tax credits into one. The purpose of the GBC is to encourage specific business activities and investments considered beneficial to the economy.
A business must qualify for one or more of these individual credits to claim the GBC. The total GBC on a tax return is the sum of all component credits for which a business is eligible in a given year. This structure simplifies the tax filing process by allowing taxpayers to aggregate multiple credits under a single set of rules.
Component Credits of the General Business Credit
The General Business Credit is comprised of a wide array of individual credits. A business cannot claim the GBC directly; it must first qualify for and calculate one or more of its specific component credits. Each of these credits has its own qualification rules, computation methods, and a dedicated IRS form that must be completed.
One common example is the Credit for Small Employer Health Insurance Premiums, calculated on Form 8941. This credit helps small businesses afford health insurance for their employees. To qualify, an employer must have fewer than 25 full-time equivalent employees, pay average annual wages below an inflation-adjusted threshold, and contribute at least 50% toward employee health insurance premiums.
Another component is the Work Opportunity Tax Credit (WOTC), calculated on Form 5884. The WOTC provides an incentive for employers to hire individuals from certain targeted groups who have faced significant barriers to employment, such as veterans and ex-felons. Employers must obtain certification that an individual is a member of a targeted group before they can claim the credit.
The Credit for Increasing Research Activities, known as the R&D credit and calculated on Form 6765, is another component of the GBC. It is available to businesses that incur expenses for qualified research activities, which involve developing new or improved products, processes, or software. The calculation can be complex, involving either a regular credit computation or an alternative simplified credit method.
Calculating the Total Allowable Credit
Once a business has calculated all the individual component credits it qualifies for, the amounts are aggregated on Form 3800, General Business Credit. The calculated credit amounts from each specific component form, such as Form 8941 or Form 6765, are transferred to the appropriate lines on Form 3800. The next step is applying the annual tax liability limitation.
The GBC is a nonrefundable credit, meaning it can reduce a taxpayer’s liability to zero, but no portion of it will be refunded beyond that. The allowable credit is limited based on tax liability. The GBC cannot exceed the business’s net income tax minus the greater of its tentative minimum tax or 25% of its net regular tax liability over $25,000.
To illustrate, consider a business with a net regular tax liability of $105,000 and a tentative minimum tax of $15,000. The 25% limitation is calculated on the tax liability above $25,000, which is $80,000 ($105,000 – $25,000). Twenty-five percent of $80,000 is $20,000.
The total allowable GBC for the year would be $85,000 ($105,000 – $20,000). If the business had calculated total component credits of $90,000, it could only use $85,000 in the current year. The remaining $5,000 would be subject to carryover rules.
Carryback and Carryforward Provisions
When a business’s calculated General Business Credit exceeds its annual tax liability limitation, the excess credit is not lost. The Internal Revenue Code provides provisions to carry the unused portion of the credit to other tax years. This ensures that businesses can eventually receive the full benefit of the credits they have earned.
The standard rule for most components of the GBC allows for a one-year carryback and a 20-year carryforward. A business must first apply the unused credit to the preceding year’s tax return. If any credit remains, it can be carried forward for up to 20 subsequent years, or until it is fully utilized.
An ordering rule applies to how these carryovers are used, as the GBC system operates on a First-In, First-Out (FIFO) basis. When applying credits in a given tax year, carryforwards from prior years are used first, starting with the oldest. After all carryforwards are applied, the current year’s GBC is used, followed by any carrybacks from subsequent years.
By requiring the oldest credits to be used first, the FIFO method minimizes the risk that a credit will expire unused. Taxpayers must track the origin year of each unused credit amount to ensure they are applied correctly and do not expire after the 20-year carryforward period.
Claiming the General Business Credit
Filing for the General Business Credit is done with the annual income tax return. Form 3800, General Business Credit, must be completed and attached to the taxpayer’s primary tax return, whether that is a Form 1040 for individuals, Form 1120 for corporations, or Form 1065 for partnerships.
Along with Form 3800, the business must also attach the specific source form for each individual component credit being claimed. For instance, if a business is claiming the Work Opportunity Tax Credit and the R&D credit, it must attach both Form 5884 and Form 6765. These source forms provide the detailed calculations and proof of eligibility for each specific credit.
The final allowable GBC amount, as calculated on Form 3800, is then transferred to the appropriate line on the main tax return. For example, on Form 1120 for corporations, this amount is entered on the line designated for the general business credit. This final entry is what ultimately lowers the taxpayer’s tax bill.