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Claiming Federal Income Tax Credits

Once you've decided that one or more of the available tax credits may apply to you, how claim these credits? 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 uninitiated 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:

  • 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.
  • 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.
  • 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 credit for interest on certain home mortgages
    • the foreign tax credit
    • the alternative fuels credit
    • the orphan drugs credit
    • the credit for qualified electric vehicles
    • the general business credit, which is made up of the following parts: the investment credit, the work opportunity credit, the alcohol fuels credit, the research credit, the low-income housing credit, the empowerment zone credit, the employer FICA credit on tips, the Indian employment credit, the enhanced oil recovery credit, the disabled access credit, the renewable-resource electricity production credit, and the CDC credit. The investment credit, in turn, is made up of the rehabilitation credit, the energy credit, and the reforestation credit.
  • Compute any carryback or carryover amounts, if you are unable to subtract the full amount of your nonrefundable credits. The foreign tax credit may be carried backward into the past two tax years and forward for five years, if necessary to use it up. Most of the components of the general business credit, including the investment credit, can be carried backward into the past year, and then forward for 20 years - if these carrybacks and carryforwards are insufficient to use up the credit, the remainder can be deducted in the 21st year.
  • Compute and subtract your refundable credits from your remaining tax liability, if any. Refundable credits include the earned income credit, the Making Work Pay credit, portions of the Child credit and the American Opportunity education credit, the first-time home buyer credit, the 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 the general business credit, 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.