10 Tax Credits for Your Small Business
by Ryan Lasker | Updated Aug. 5, 2022 - First published on May 18, 2022
Small businesses need a few things to succeed: great employees, a solid product or service, and cash. Cash is a big one.
One of the most effective ways to keep cash in your business is by taking advantage of tax credits.
Overview: What is a tax credit?
A tax credit reduces your business’s tax bill by a certain dollar amount or percentage of a specific cost. The IRS uses tax credits to influence business decisions. Most tax credits benefit businesses and their employees, the environment, or the public.
Tax credits offer dollar-for-dollar discounts on your tax bill, making it one of the most effective ways to reduce your tax liability. Dozens of tax credits exist, some geared specifically for small businesses. Don’t miss out.
More important than knowing how to calculate the tax credit is simply knowing it exists. You have tax software and tax professionals to help you file your business tax return, but being aware of available tax credits can serve you well and save you money when making business decisions.
Tax credit vs. tax deduction: What's the difference?
Tax deductions and tax credits bring down your business’s tax bills in different ways because they enter your income tax calculation at different stages.
Deductions, also called tax shields, come at the beginning of the tax calculation. You subtract deductions from your business revenue to arrive at taxable income.
Revenue - Deductions = Taxable Income
When people talk about writing off business expenses, they’re talking about tax deductions. You can deduct ordinary and necessary expenses related to running your business, like the cost of goods sold, payroll, and rent.
Tax credits, on the other hand, don’t get factored in until you’ve multiplied your taxable income by your effective tax rate. Corporations pay a flat 21% tax on income. For all other business types, the effective tax rate depends on your income.
Taxable Income x Effective Tax Rate = Preliminary Tax Liability
You subtract tax credits directly from your preliminary tax liability.
Preliminary Tax Liability - Tax Credits = Tax Liability
Since tax credits come at the last stage of the calculation, they have a more substantial impact on your bottom line. Let’s consider the difference between a $100 deduction and a $100 tax credit.
The impact of a small business tax deduction is the deduction amount multiplied by your effective tax rate. A tax credit’s tax savings comes at face value.
A $100 deduction reduces taxable income by $100. If you’re a corporation, the deduction only reduces your tax bill by $21 ($100 x 0.21). A $100 tax credit reduces your tax liability by the entire $100.
Are there specific tax credits for small business owners?
Small businesses are the backbone of the U.S. economy; they account for about 44% of U.S. economic activity, according to the U.S. Small Business Administration (SBA).
To encourage the growth of a critical sector, the IRS offers certain tax credits exclusively to small businesses.
These small business tax breaks are limited by the business’s revenues, the number of employees, or both. Each credit comes with a list of restrictions and exclusions, so consult a tax professional before you bank on receiving a particular tax credit.
The 10 small business tax credits business owners should know about
I could write a (very dull) book about all the tax credits your business might take. Instead, let’s go through some of the most advantageous tax credits geared for small businesses.
1. General Business Credit
The following credits -- except the last three -- fall under the general business tax credit.
You fill out one IRS form for each general business tax credit for which your small business qualifies. Then, you tally the credits on Form 3800 to arrive at the total general business tax credit.
The general business tax credit cannot zero out your tax liability in any year, and there are restrictions on the amount of your general business credit.
The good news: If you can’t take your full general business tax credit in one year, you might use the remainder to get a refund on taxes paid last year, called a tax credit carryback.
If you’re a new business or one that hasn’t had a tax liability in the past, you can also save it to reduce tax bills for up to 20 years in the future, a carryforward.
2. Credit for Small Employer Health Insurance Premiums
The Credit for Small Employer Health Insurance Premiums incentivizes small businesses to offer health insurance to full-time employees. Businesses with over 50 employees must offer health insurance, so the tax credit encourages smaller businesses to offer plans on their own volition.
The tax credit reimburses businesses for up to 50% of employer-paid insurance premiums. Non-profit organizations, which don’t pay federal income tax, can apply for a refund up to 35% with this tax credit.
Several strings are attached. Your business must:
- Have fewer than 25 full-time equivalent (FTE) employees
- Have an average employee salary of $55,000 (in 2019, indexed for inflation)
- Pay at least 50% of premium costs
- Offer health insurance benefit to all full-time employees
Businesses can only claim the credit for two consecutive years.
Calculating the Small Business Health Care Tax Credit is infamously tricky. Check out the government’s SHOP tax credit calculator to estimate your credit amount. When you’re ready, file with Form 8941.
3. Credit for Small Employer Pension Plan Startup Costs
Don’t let the word “pension” make you skip out on this credit.
When you offer employees a retirement plan, such as a 401(k), your business might qualify to get a tax credit worth half of the costs of setting up and educating your employees about the plan, up to $500.
Your business must have:
- 100 or fewer employees paid at least $5,000 last year
- At least one non-highly compensated employee, earning less than $130,000 in 2020
Your business can’t have offered a similar retirement plan in any of the previous three years to the same group of employees. You can claim this tax credit for three consecutive years, starting with the year before your retirement plan goes live. File with Form 8881.
If you take this tax credit, you can’t take a tax deduction for the retirement plan’s administrative and education costs. But as I said before, tax credits are often more advantageous than a tax deduction.
4. Credit for Employer-Provided Childcare Facilities and Services
If you chip into your employees’ childcare costs, you can claim a credit worth up to 25% of your contribution.
You can further increase the credit by 10% of your costs associated with offering your employees childcare resources and referral information. The credit is capped at $150,000 per year. Use Form 8882 to file.
Don’t confuse this credit with the Child and Dependent Care Tax Credit, a personal tax credit. There is no per-child maximum for the Credit for Employer-Provided Childcare Facilities and Services.
5. Disabled Access Credit
When you spend to make your small business more accessible, you can claim a tax credit for half of your costs, up to $5,000.
The IRS defines accessibility broadly. For example, you can get a credit for the cost of:
- Interpreters for those who are hearing impaired
- Taped texts for those who are visually impaired
- Equipment or equipment modifications for those with disabilities
To qualify, your business must have no more than 30 full-time employees or (not and) have earned $1 million or less in the year before you claim the credit. File with Form 8826.
6. Work Opportunity Credit
We know that diverse, equitable, and inclusive workplaces foster more innovation and provide a better experience for customers and employees. Equal employment opportunity (EEO) makes it your job as a business owner to give a fair shot to all job applicants.
When you hire someone from a group the IRS identifies as having “consistently faced significant barriers to employment,” you can claim a tax credit whose maximum ranges between $1,200 and $9,600, depending on the employee’s earnings.
The IRS says the credit is available to employers who hire someone from these groups. The list comes straight from the IRS website:
- Long-term family assistance recipient
- Qualified recipient of Temporary Assistance for Needy Families (TANF)
- Qualified veteran
- Qualified ex-felon
- Designated community resident
- Vocational rehabilitation referral
- Summer youth employee
- Supplemental Nutrition Assistance Program (SNAP) benefits recipient
- Social Security Insurance (SSI) recipient
- Qualified long-term unemployment recipient
The IRS defines each of these groups in more detail, so consult the IRS website or a tax professional to see if your new hire qualifies.
To claim the credit, the employee must work for you for at least 120 hours during the year, and you must request certification through Form 8850 within the 28 days after the eligible employee starts at your company.
If approved to receive the credit, you file Form 5584 in the year the eligible employee starts at your company.
7. Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips
Restaurant owners, this one’s for you. Known better as the FICA tip credit, the credit reimburses employers for a portion of FICA taxes paid on tipped employees’ wages.
Federal Insurance Corporation Act (FICA) taxes fund two federal programs: Medicare and Social Security. Employers and employees each pay a 7.65% FICA tax on employee earnings, including tips.
Employers use the FICA tip credit to get back FICA taxes paid on wages that exceed $5.15 per hour. Why that amount? It was the federal minimum wage in 2007, and the credit hasn’t been updated since.
For example, if a tipped employee paid $5.15 per hour received an average of $10 in tips per hour, the employer could get a $0.76 tax refund for every hour worked ($10 x 0.0765).
File for the FICA tip credit with Form 8846.
8. New Qualified Plug-In Electric Drive Motor Vehicle Credit
Eyeing an electric car for your small business? You might be able to claim a tax credit of up to $7,500. The IRS restricts the credit to those buying a new electric vehicle (EV). The credit depends on the type of car and its energy efficiency.
Thinking about leasing an electric car? You’re not able to claim the tax credit, but the manufacturer can. It’s common for them to lower your monthly payments, giving you the effect of the credit.
The credit also phases out starting when a manufacturer reaches 200,000 electric car sales. Tesla and General Motors are the only two companies so far to hit that target. So, if you’re looking at a new Model 3 Tesla, don’t count on a tax credit.
9. Employee Retention Credit
A new business tax credit, the Employee Retention Credit incentivizes small businesses to keep their employees on the payroll through the COVID-19 pandemic.
The Employee Retention Credit is part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Businesses that either closed or experienced a significant decline in sales may qualify for the credit.
You can get a tax credit for employee wages paid between March 12, 2020, and January 1, 2021. The maximum tax credit is $5,000 per employee you retain.
Most tax credits are non-refundable, meaning the tax credit can’t cause you to have a negative tax liability. The Employee Retention Credit is refundable, meaning the credit might qualify you for a refund check from the IRS.
For example, if your federal tax liability is $3,000 before credits, and you qualify for the $5,000 Employee Retention Credit, the IRS will send you a check for $2,000 ($5,000 - $3,000).
A unique aspect of the credit: It allows eligible employers to reduce upcoming federal tax deposits by the amount of the tax credit. You can also file Form 7200 now to receive the tax credit early.
10. Paid Sick Leave and Family Leave Credits
The Families First Coronavirus Response Act (FFCRA), passed amid the COVID-19 pandemic, added time-off requirements for small and medium employers. Tax credits were introduced to offset the costs of the new policy.
The FFCRA states that employers with fewer than 500 employees must offer up to two weeks of paid time off to employees experiencing symptoms of COVID-19 or caring for someone affected by the pandemic.
The FFCRA also requires employers to offer up to 10 weeks in additional paid family and medical leave for employees who need time off to take care of a child because of COVID-19 related school closures.
If you employ fewer than 50 people, you can apply for an exemption if providing additional time would threaten your business’s future. If your employees take advantage of additional paid time off, you can get a credit for a portion of their wages.
These tax credits are also refundable, and you can receive that IRS check before the next tax season with Form 7200.
Don’t miss a tax credit
Federal business tax credits have the power to slash your business tax bill. Consult your tax advisor if any of these tax credits seem applicable to your small business.
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