EA Part 2 Business Tax Credits: Research Credit, Work Opportunity, and More

Tax credits are more valuable than deductions because they reduce tax liability dollar-for-dollar rather than reducing the income base. Part 2 tests the major business credits with questions on eligibility, calculation methods, and carryover rules. Understanding how individual credits work — and how they fit into the general business credit framework — gives you a reliable set of points on exam day.

Research and Development Credit: Section 41

The research credit (also called the R&D credit) rewards businesses for increasing their qualified research expenditures. The credit is one of the most complex business credits, and Part 2 tests the two computation methods.

Regular Credit Method

The regular credit is 20% of qualified research expenses (QREs) that exceed a base amount. The base amount is calculated using the taxpayer's historical ratio of QREs to gross receipts, applied to the average gross receipts for the four preceding tax years. A floor of 50% of current-year QREs applies — the base amount cannot exceed 50% of current-year QREs.

Alternative Simplified Credit (ASC)

The ASC, elected on Form 6765, avoids the complex base amount calculation:

• Credit equals 14% of QREs that exceed 50% of the average QREs for the three preceding tax years
• If the taxpayer had no QREs in any of the three preceding years, the credit is 6% of current-year QREs

Qualified Research Expenses

QREs include wages paid for qualified services, supplies used in research, and 65% of amounts paid to third-party contractors performing qualified research. Research must be technological in nature, conducted to discover information that eliminates uncertainty about a product's design, function, or performance.

The taxpayer must reduce the deduction for QREs by the amount of the credit (or make an election to take a reduced credit and preserve the full deduction).

Work Opportunity Tax Credit (WOTC)

The WOTC encourages employers to hire individuals from target groups who historically face barriers to employment. The credit amount varies by target group and hours worked.

Target Groups

Eligible groups include:

• Qualified IV-A recipients (TANF recipients)
• Qualified veterans (with various subcategories based on disability and unemployment duration)
• Ex-felons hired within one year of conviction or release
• Designated community residents
• Vocational rehabilitation referrals
• Supplemental Nutrition Assistance Program (SNAP) recipients
• Supplemental Security Income (SSI) recipients
• Long-term family assistance recipients
• Qualified long-term unemployment recipients (unemployed for at least 27 weeks)

Credit Amounts

For most target groups, the credit is:

• 25% of first-year wages up to $6,000 if the employee works at least 120 hours but fewer than 400 hours — maximum $1,500
• 40% of first-year wages up to $6,000 if the employee works at least 400 hours — maximum $2,400

Special rules apply to veterans (higher wage caps up to $24,000 for disabled veterans), summer youth employees, and long-term family assistance recipients (who generate a second-year credit as well).

Employers must file Form 5884 to claim the WOTC and must obtain certification from the state workforce agency before or shortly after the employee begins work.

Small Business Health Care Tax Credit

Small employers that provide health insurance to employees may claim a credit of up to 50% of premiums paid (35% for tax-exempt employers). To qualify:

• Fewer than 25 full-time equivalent employees
• Average annual wages below a threshold (approximately $56,000, indexed for inflation)
• The employer must pay at least 50% of single coverage premiums through a SHOP marketplace plan

The credit phases out as the number of employees and average wages increase. It is available for only two consecutive tax years after 2013.

Disabled Access Credit

The disabled access credit helps small businesses cover the cost of making their facilities accessible to individuals with disabilities under the Americans with Disabilities Act. The credit equals 50% of eligible access expenditures between $250 and $10,250.

Maximum credit: 50% × ($10,250 − $250) = $5,000

Eligible businesses: those with gross receipts of $1,000,000 or less in the prior year, or fewer than 30 full-time employees in the prior year.

The expenditures must remove barriers, provide accessible equipment, provide sign language interpreters, or modify materials for people with hearing or visual impairments.

General Business Credit: Ordering and Carryover Rules

Most business credits flow into the general business credit (GBC), which is reported on Form 3800. The GBC framework determines the order in which credits are applied against tax and what happens to unused credits.

Ordering Rules

Within the GBC, credits are applied in a specific order:

1. Credits carried over from prior years (oldest carryovers first)
2. Credits earned in the current year
3. Credits carried back from subsequent years (if applicable)

Tax Limitation

The GBC cannot reduce regular tax below the greater of:

• The tentative minimum tax (for taxpayers subject to AMT purposes)
• 25% of regular tax in excess of $25,000

Credits that cannot be used due to the tax limitation are carried over.

Carryback and Carryforward

Unused GBC credits are:

• Carried back 1 year first
• If still unused, carried forward for 20 years

The carryback is applied to the earliest available year. Carryforward years are used in order. An election can be made to forgo the carryback and carry credits forward only.

Basis Reduction Rule

When a business claims certain credits (such as the investment tax credit), it must reduce the basis of the property generating the credit by all or part of the credit amount. This prevents the taxpayer from getting both the full credit and a full depreciation deduction on the same cost.

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