Monday, October 11, 2010

Tax Credits

1. What is a tax credit?

It is a dollar for dollar discount on the total taxes an individual or entity may owe.

2. What do you get tax credits for?

Sometimes the government will give businesses tax credits for including non-petroleum gas usage, motor vehicle alternatives, welfare relief employment, and rising research expenses in their operations. The government may also give tax credits for disaster relief or property development for certain buildings. There are also some other non-standard reasons tax credits may be given.

Individuals may also receive tax credits for some similar activities as businesses, such as adoptions and using solar panels to power their homes. They are given these credits to directly reduce their tax amount, dollar for dollar. If you made $100,000 and your tax rate is 20%, you would owe $20,000 dollars. If you received a tax credit of $5,000 for using solar panels, you could reduce your total tax amount to $15,000.

The main difference between individuals and businesses, though, is that an individual can only use tax credits for the following year. Businesses, though, are able to use any tax credits at any time.

3. How does it affect the company's shares?

Tax credits are added to the balance sheet, usually in footnotes. When performing fundamental analysis, they will affect the book value of the shares.

For example, if you leave the tax credits out of your analysis and the market share price matches the book price, adding the tax credits will leave the market share price undervalued. If you are a value investor, this is exactly what you are looking for in your analysis.

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