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Credits for Certain Taxes

You might find it hard to believe, but sometimes the IRS does have a heart: it occasionally gives certain people a break for taxes that might be considered unfair. There are four types of business tax credits that give a "rebate" for certain kinds of taxes: the credit for FICA tax on tips, the gasoline tax credit, the credit for prior year's AMT, and the credit for foreign income taxes.

Credit for FICA tax on tips. Under current law, employees who get $20 or more in tips in a single month must report their tips to their employers. If you have tipped employees, you have to pay Social Security and Medicare (FICA) taxes to the tune of 7.65 percent on tips that are reported to you, even though you don't have any control over the amounts. The purpose of the rule is to make sure that tipped employees are adequately covered by Social Security pension, disability, and survivors' benefits. However, the rule was seen to place a particularly heavy burden on the restaurant industry.

So, if your business is one that provides food or beverages for customers to consume on or off the premises, and if your waiters, waitresses, or delivery personnel are customarily tipped by your patrons, you're entitled to a tax credit for any FICA taxes you pay on the tips, whether or not your employee reports the tips. Before 1997, tips for food not consumed on the premises (for example, tips for pizza delivery) did not count toward this credit.

Did You Know?

Did You Know?

The FICA tip credit continues to be based on the old minimum wage of $5.15 per hour, rather than the new minimum wage of $7.25. As a result, even though the minimum wage has increased, the amount of the tip credit will not be reduced.

An employer may claim a credit for FICA tax paid on tips received by employees for serving or delivering food or beverages consumed on the employer's premises if tipping is customary. Employers may claim the FICA tip credit even if employees do not report the tips. The credit equals the employer's FICA obligation (7.65 percent) attributable to tips that exceed those tips treated as wages for purposes of the minimum wage requirements of the Fair Labor Standards Act (FLSA).

The upshot of all this? Your workers receive Social Security credits toward their future benefits on account of the tips, but you don't have to pay for these benefits. Note that there's an exception to the general credit rule: if you pay your employees below the minimum wage, with the expectation that tips will bring them up to the minimum, you can't claim the credit for FICA on the portion of the tips that is used to bring them up to the minimum wage.

No double-dipping is allowed: if you are eligible for and decide to claim this credit, you can't deduct the FICA taxes on which the credit is claimed. Because tax credits are generally worth more than deductions, you're generally better off with the credit.

The FICA tax credit is claimed on Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, and is part of the general business credit. The total of all your general business credits can't reduce your current year's tax bill below the larger of (a) your tentative minimum tax or (b) 25 percent of the part of your regular tax bill that exceeds $25,000.

Gasoline tax credit. You can claim a credit for any federal excise taxes you pay on gasoline and special fuels (like undyed diesel, heating oil, liquified petroleum gas, and compressed natural gas), when you use the fuel for certain purposes: for farming; for nonhighway purposes of your trade or business; for intercity, local, or school buses; or for export or foreign trade. You can't claim this credit for any personal (nonbusiness) use, so forget about claiming it for your snowmobile or pleasure boat! The credit is claimed on Form 4136, Credit for Federal Tax Paid on Fuels. It is refundable, meaning that the IRS will pay it to you even if you have no tax liability for the year.

Foreign tax credit. You can claim a credit for foreign income taxes, or taxes imposed by possessions of the U.S., that you paid or accrued during the tax year. For example, you might have become liable for foreign taxes on profits from overseas operations or investments. You can elect to deduct these taxes instead of taking the credit, if you prefer, although claiming the credit will generally save you more money. The credit is claimed on Form 1116, Foreign Tax Credit. Like most credits, it can't be used to reduce your alternative minimum tax (AMT).

Business Tools

Among the Business Tools are Form 1040 and Form 1116. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

Credit for prior year minimum tax liability. Individuals who owe alternative minimum tax (AMT) attributable to items (such as income from the exercise of an incentive stock option) that defer recognition of income (rather than permanently affect taxable income) have been permitted to apply their minimum tax credit against their regular tax liability, but only to the extent that their regular liability exceeds their tentative minimum tax.

A portion of the minimum tax credit can be applied against a taxpayer's entire regular tax liability and is refundable. The AMT refundable credit amount is the greater of (1) the lesser of $5,000 or the long-term unused minimum tax credit or (2) 20 percent of the long-term unused minimum tax credit. The "long-term unused minimum tax credit" for a tax year is the portion of the minimum tax credit attributable to a taxpayer's adjusted net minimum tax for tax years before the third tax year immediately preceding the tax year.

The AMT refundable credit amount is phased out for higher income taxpayers using the same threshold amount and applicable percentage used to phase out personal exemptions. Making the credit refundable provides some relief to individuals who have exercised incentive stock options and subsequently sold the stock at a loss.

The credit is claimed on Form 8801, Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts, or on Form 8827, Credit for Prior Year Minimum Tax - Corporations. If you have paid AMT in prior years and think you might be eligible for this credit, see your tax adviser. The AMT rules are a morass of confusion, and interpretation of them is best left to professionals.