What is a Corporate Tax Credit?

Corporations are legal entities with specific laws and regulations determining their taxes. Most are not taxed at the individual rates of their owners, a key reason for using the corporate structure. Tax credits reduce the overall tax liability of a corporation, providing a savings to the corporation which generate additional profits that can be distributed to owners as dividends or reinvested back into operations.

Identification

Tax credits are not the same as tax deductions. They are, in fact, much more popular and beneficial because they usually save a corporation more money. Deductions reduce a company's taxable income, which means the savings is limited to the tax that would have otherwise been paid by the corporation on the amount of the deduction. Only a relatively small percent of the deduction, 35% or less in the U.S., is actually realized as savings. Tax credits, on the other hand, directly reduce the amount of taxes owed by the full amount of the credit, regardless of the corporate tax rate. Credits are after-tax, and are realized entirely as savings to the corporation.

Function

Legislators create tax credits as an incentive to get businesses to conduct some certain desirable behaviors. These usually include using cleaner fuels and hybrid vehicles, doing research on pharmaceuticals and other beneficial products, or charitable donation. Other tax credits compensate corporations for the taxes they pay overseas or for profit-sharing. Because tax credits work as an incentive, they often create increased tax revenues for a government by expanding overall business spending.

History

The first taxes in the United States were based on consumption, that is, they were sales taxes on the purchase of things like sugar, tobacco, or alcohol. For a long time, the federal government's main source of income was the assessment of tariffs against foreign imports. The national income tax began in 1862 to help fund the Civil War, and was as low as 3%. The 16th Amendment made the income tax permanent in 1916. In 1943 the federal withholding tax, which businesses pay on their employees, greatly increased the number of Americans subject to federal tax. Over time, the huge increase in the types and scope of federal taxes has made tax breaks of all kinds, including tax credits, very powerful and important incentives to business.

Types

There are two main types of tax credits. Refundable tax credits, also called non-wastable, are payable to a corporation even if they reduce its overall tax liability below zero, actually resulting in a tax refund from the government. Research and development tax credits are common refundable tax credits. Non-refundable, or wastable, tax credits are not paid to a corporation if they would result in a net payment from the government by taking their tax liability below zero. For a list of corporate tax credits, see the resources below.

Potential

Because corporations can only persist in activities that are profitable, the greatest potential of tax credits is to stimulate activity that might no otherwise occur in a capitalist system. The production of pharmaceutical drugs, for instance, requires very expensive research and development that would be prohibitive, so the argument goes, without government assistance in the form of tax credits. Going forward, tax credits will be instrumental in the development of clean energy technology, encouraging sustainable business practices, and the building of modern infrastructure. The tax credit for hybrid and electric vehicles is an early step in this direction.