The research credit is one of the credits that make up the general business credit, and section 38(c) caps how much of the general business credit can offset income tax in a year. A company can therefore earn a larger credit than it is allowed to use. The unused amount carries back one year and then forward up to 20 years under section 39.
How much is usable in a given year depends on regular tax, any minimum tax, other credits, and whether the taxpayer is a corporation or an individual. Our guide to R&D tax credit carryforward covers what happens to a credit once it is carried, including how states treat unused credits.
How the Section 38(c) Limit Works
For individuals, estates and trusts, the general business credit for a year cannot exceed net income tax minus the greater of:
- tentative minimum tax for the year, or
- 25 percent of net regular tax liability above $25,000.
Net income tax is regular tax plus any alternative minimum tax, reduced by certain other nonrefundable credits that apply first. Net regular tax liability is regular tax reduced by those same credits.
Corporations use a modified rule. Section 38(c)(6)(E) replaces the greater-of test for corporations with 25 percent of net income tax above $25,000, so tentative minimum tax does not enter the corporate computation. For most C corporations, net income tax is regular tax after those other credits. The corporate alternative minimum tax, in effect for tax years beginning after December 31, 2022, applies only to large corporations, generally those with average annual adjusted financial statement income above $1 billion. For those corporations, it is included in net income tax.
The $25,000 is fixed in the statute and is not adjusted for inflation. It drops to $12,500 for a married individual filing separately, unless the spouse has no business credits for the year, and members of a controlled group share a single $25,000.
| Taxpayer | Credit cannot exceed |
| Individual, estate or trust | Net income tax minus the greater of tentative minimum tax or 25% of net regular tax liability above $25,000 |
| Corporation | Net income tax minus 25% of net income tax above $25,000 |
A Worked Example
The figures below are hypothetical. They assume a C corporation not subject to the corporate alternative minimum tax, with no other credits, and they ignore section 280C and state tax. In year 2 the company has $300,000 of regular tax and earns a $280,000 research credit.
| Step | Amount |
| Regular tax, year 2 | $300,000 |
| Less 25% of tax above $25,000 | $68,750 |
| Limit for year 2 | $231,250 |
| Research credit earned in year 2 | $280,000 |
| Unused after year 2 | $48,750 |
| Absorbed by carryback to year 1 | $36,250 |
| Carried forward to year 3 | $12,500 |
Although the credit nearly equals its tax, the company still owes $68,750 for year 2. The carryback depends on room under year 1’s own limit. If year 1 regular tax was $160,000, the year 1 limit was $126,250, which is $160,000 less 25 percent of $135,000. With $90,000 of credits already used that year, $36,250 of room remains, and that amount can be claimed as a refund of year 1 tax. The remaining $12,500 carries forward.
Minimum Tax and the Eligible Small Business Rule
For individuals, tentative minimum tax can set the limit. Take an individual with $120,000 of regular tax and $95,000 of tentative minimum tax (hypothetical figures, no other credits). Tentative minimum tax is greater than 25 percent of net regular tax above $25,000 (that figure is $23,750), so under the standard rule general business credits are limited to $120,000 less $95,000, or $25,000.
The eligible small business rule changes that for the research credit. Under section 38(c)(4)(B)(ii), the research credit of an eligible small business is a specified credit, and for specified credits tentative minimum tax is treated as zero. In the example, the limit for the research credit becomes $96,250, which is $120,000 less $23,750. Specified credits are tested separately, and their limit is reduced by any other general business credits allowed for the year.
An eligible small business is a corporation whose stock is not publicly traded, a partnership or a sole proprietorship, with average annual gross receipts of $50 million or less for the three preceding tax years. The $50 million is a fixed statutory figure, applied with aggregation rules similar to section 448(c). For a credit from a partnership or S corporation, the partner or shareholder must also meet the gross receipts test for the year the credit is treated as a current year business credit.
Because the corporate limit already leaves out tentative minimum tax, the rule matters mostly to individuals: sole proprietors, partners and S corporation shareholders.
Individual owners face one more cap. Section 41(g) limits an owner’s research credit to the tax attributable to taxable income from that business, with any excess carried under the section 39 rules. Pass-through owners are covered in a separate article.
Ordering, Carryback and Carryforward
Older credits go first. Each year’s allowable credit is the sum of carryforwards, the current year’s credit and carrybacks, and the Form 3800 instructions apply them in that order, earliest carryforwards first. Among different credits, section 38(d) follows the order of the list in section 38(b), where the research credit is fourth.
The carryback comes before the carryforward. Under section 39, an unused credit goes first to the preceding tax year and then to each of the next 20 years, to the extent each year’s limit has room. Section 39 provides no election to skip the carryback. A carryback is claimed on an amended return or an application for tentative refund (Form 1139 for corporations, Form 1045 for individuals, estates and trusts).
Other items in the same year change the room. Anything that lowers regular tax lowers the limit too. A large deduction on a 2025 return, such as the section 174A deduction for unamortized 2022 to 2024 domestic research costs, can reduce the room for credits in that year.
When the Payroll Election Is the Better Route
For a young company with little income tax, the payroll election under section 41(h) can put the credit to use sooner. A qualified small business, meaning gross receipts under $5 million for the tax year and no gross receipts for any year before the five-tax-year period ending with that year, may elect to apply up to $500,000 of research credit a year (for tax years beginning after December 31, 2022) against the employer share of social security tax and then Medicare tax. The election is made on Form 6765 with a timely filed original return, including extensions, cannot be made on an amended return, and is available for up to five years. The elected amount is not treated as an income tax credit except for section 280C purposes, so it sits outside the section 38(c) limit. Our Form 8974 guide covers how the offset reaches payroll, and our post on R&D tax credits for loss-stage companies covers the wider options for companies without taxable income.
The limit decides when a credit becomes usable, so it is worth modeling alongside the credit computation. To discuss your position, see CSSI Services’ R&D tax credit services or request a free analysis.
Frequently Asked Questions
What is the general business credit limitation?
The cap in section 38(c) on how much of the general business credit, including the research credit, can offset income tax in a year. It is computed from net income tax, tentative minimum tax (for individuals, estates and trusts) and a 25 percent floor on tax above $25,000.
Can the R&D credit offset the alternative minimum tax?
For an eligible small business, generally yes. Its research credit is a specified credit, so tentative minimum tax is treated as zero in the limit. Partners and S corporation shareholders must also meet the $50 million gross receipts test themselves.
Does tentative minimum tax limit a C corporation’s R&D credit?
Not under the corporate version of the limit, which uses 25 percent of net income tax above $25,000. The corporate alternative minimum tax applies only to large corporations, generally those with average annual adjusted financial statement income above $1 billion, and for them it is included in net income tax.
How long can an unused R&D credit be carried?
Back one year and forward 20 years, earliest year first. Section 39 provides no election to skip the carryback.
Is the payroll election subject to the general business credit limit?
No. The elected amount is applied against employer payroll taxes and is not treated as an income tax credit, except for section 280C purposes. Only a qualified small business can make the election, and only on a timely filed original return.
This article provides general information about federal tax rules and is not tax advice. Speak with your tax adviser about your specific circumstances.
