Tax Credits for Small Businesses: A Detailed Guide to Savings

Small business owners have limited budgets compared to bigger companies, so they should maximize tax credits. What kinds of credits are available to lower small business taxes? We’ll discuss the potential tax credit options you can explore to save more money on taxes.

What are Tax Credits?

A tax credit is the amount you’re allowed to remove, dollar-for-dollar, from your taxes. Small business tax credits can lower overall tax costs, helping you maximize your business income. There are three types of credits: nonrefundable, refundable, and partially refundable.

A tax credit can lower your overall tax liability to 0 and even incur an additional refund if you meet all the requirements. However, each tax credit has criteria, so you must determine if your business meets the requirements before you include them in your tax forms.

5 Tax Credits for Small Businesses

Here are five examples of tax credits small businesses can apply for a possible tax deduction.

1. Small Business Health Care Tax Credit

This credit is designed to motivate small companies and tax-exempt organizations to offer health insurance plans to team members for the first time or maintain current ones. This credit targets companies that employ moderate to low-income workers.

Eligibility Criteria

To qualify for this credit, the company should have fewer than 25 full-time employees on its payroll. The average wage for these employees should be below $56,000, but this amount is adjusted annually for inflation. The company must also pay at least 50% of health care premiums. The credit is available to companies for two consecutive years only.

Calculation Method

Companies can get a maximum credit of 50% of premiums paid, while tax-exempt organizations can get up to 35%. The smaller the company, the bigger the credit they can receive.

Application Process

Your company must file Form 8941 to calculate and claim the credit. For small businesses, this credit should be part of one’s general business credit or your income tax return on Form 3800.

Limitations And Considerations

Companies may claim this credit for two consecutive years only. To qualify, they must enroll in a Small Business Health Options Program (SHOP) plan.

2. Work Opportunity Tax Credit (WOTC)

The Work Opportunity Credit is a federal credit that encourages businesses to hire and retain veterans and those who have faced barriers in finding jobs. This credit incentivizes workplace diversity and provides more work choices to qualified groups.

Target Groups

This credit covers individuals who are part of these targeted groups:

• Designated community residents (DCR)
• Supplemental Nutrition Assistance Program (SNAP) recipients
• Qualified veterans
• Qualified long-term unemployment recipients
• Ex-felons
• Qualified short-term and long-term IV-A recipients
• Summer youth employees
• Supplemental Security Income (SSI) recipients
• Vocational rehabilitation referrals

Credit Amount

The credits equal 40% of up to $6,000 wages paid for the first year, which means you can get up to $2,400 from this credit. The premise is that that person worked at least 400 hours of services for that employer. A 25% rate is applied to individuals who perform over 120 but less than 400 hours of service. For certain qualified veterans, up to $24,000 of their wages paid can be considered for the WOTC.

Certification Process

Employers must file Form 8850, or Pre-Screening Notice and Certification Request, 28 days from the employee’s starting date. The first page of the form, which the employee should complete on or before the job offer day, outlines the conditions for qualifying for this credit.

Calculation And Claiming

Companies must complete Form 5884 when filing tax returns to claim this credit, while small businesses must claim it under their general business credits.

3. Research & Development (R&D) Tax Credit

The Research and Development (R&D) tax credit is a federal benefit that provides companies that engage in research activities with a reduction in tax liability for local expenses. You can claim this credit if your company participates in R&D activities for software, processes, or products.

Qualified Research Activities

To qualify for this tax credit, your company should engage in activities that pass the R&D tax credit’s 4-part test: technological, elimination of uncertainty, process of experimentation, and new or improved business components.

Calculation Methods

There are two ways to calculate this credit: the regular and Alternative Simplified Credit (ASC) methods. The regular credit method allows for a credit of 20% of a business’s current QREs or qualified research expenses over a base amount. The ASC method looks at the QREs over three previous years. ASC is defined by 14% of QREs in the current year, above 50% of the average QREs in the last three years.

Special Provisions For Small Businesses

Companies can use the R&D tax credit to offset their payroll taxes. In certain states, you are permitted to carry forward the credit so your company can save more on taxes in the future.

Documentation Requirements

Proper documentation is required to qualify for the small business R&D tax credit. Therefore, you should be ready with supporting documents that justify the expenses claimed for R&D purposes.

Common Misconceptions

Many small business owners mistake this credit for being exclusively available to scientific research, but the modern definition of R&D grants companies flexibility to claim this credit. Companies can maximize this credit if the activities satisfy the four-part test and have supporting documents.

Moreover, this credit isn’t exclusively for new products, processes, or software. You can use it to improve currently available offerings.

4. Retirement Plan Startup Costs Tax Credit

The Retirement Plans Startup Costs tax credit is an income tax credit that lowers barriers for startups to start retirement plan contributions for three years.

Eligibility Requirements

To qualify for this credit, your startup must have a maximum of 100 employees who receive at least $5,000 in wages. At least one team member must be a non-highly compensated employee.

Credit Amount

This particular credit offers up to $5,000 for three consecutive years. The credit is equivalent to 50% of your eligible startup costs.

Qualified Retirement Plans

Setting up any of the following retirement plans can help your company qualify for this credit:

• 401 (k) plans
• Simplified Employee Pension (SEP) plans
• SIMPLE IRA plans
• 403 (b) plans
• Application Process

Companies must accomplish and file Form 8881 or Credit for Small Employer Pension Plan Startup Costs to claim this credit. The first part of the form covers qualified startup costs, and the second part is used if the company has an eligible automatic contribution arrangement.

5. Disabled Access Credit

The Disabled Access Credit is a non-refundable tax credit for small businesses that incur additional expenses to better accommodate people with disabilities. These expenses may include installing a wheelchair ramp or buying headphones for those with hearing impairments.

Eligible Small Businesses

To qualify for this tax credit, companies must have incurred a maximum of $1 million in gross receipts or employ 30 or fewer full-time employees.

Qualifying Expenditures

According to the IRS, the expenses must address the removal of barriers, provide accessible formats like audio or barrier, or involve adaptive equipment.

Credit Calculation

The credit equals 50% of eligible expenses over $250 but not exceeding $10,250. You’re not allowed to claim the credit for the first $250 worth of costs, and the maximum amount you can claim is $5,000.

Claiming The Credit

You can claim this credit by completing Form 8826 or Disabled Access Credit and including it with your tax return. It is considered part of the general business tax credit.

5 Industry-Specific Tax Credits for Small Businesses

Some businesses can qualify for certain tax credits if they’re in specific industries.

1. Energy-Efficient Commercial Buildings Tax Deduction (Section 179D)

This tax benefit allows you to claim up to $5.00 per square foot worked. This credit provides benefits to businesses that implement energy-efficient practices and technologies within commercial buildings. Companies that work on buildings owned by Indian tribal governments, Alaska native organizations, or government entities can qualify.

2. New Markets Tax Credit

The New Markets Tax Credit (NMTC) incentivizes economic and community development in distressed areas. NMTC investors provide capital to community development entities or CDEs and are given credits against their federal tax obligations.

NMTC investors can claim their credits as early as seven years for 39% of the project. Applicants must apply as CDEs to qualify for this credit.

3. Low-Income Housing Tax Credit

The Low-Income Housing Tax Credit provides a tax incentive to rehabilitate or build budget-friendly rental housing for low-income families. This credit subsidizes the costs to encourage investors to provide housing options.

The annual credit is equivalent to a percentage multiplied by the project’s qualified basis. The credits cannot be claimed until the project is finished.

4. Renewable Energy Tax Credits

These credits encourage companies to adopt eco-friendly energy sources by lowering their tax liability. There are various renewable energy tax credits, such as the Solar Investment Tax Credit (ITC) and Wind Production Tax Credit (PTC).

5. Historic Rehabilitation Tax Credit

This credit is an indirect subsidy to finance historic building rehabilitation with a 20% credit for qualified expenses. This credit can’t be used for home renovations. A three-part application is involved in this credit, including presenting information on the building, describing its condition and rehabilitation plans, and the certified rehabilitation part.

State-Specific Small Business Tax Credits

Select states offer tax credit programs for small businesses. These programs include state research and development, investment, and job creation tax credits. It would be best to confer with state tax authorities to confirm if your state offers programs you can apply for.

COVID-19 Related Tax Credits

At the height of the pandemic, the government offered additional credits to help businesses stay afloat.

1. Employee Retention Credit

This refundable tax credit was available to businesses that paid their workers qualified workers after March 12, 2020. Its goal was to keep people employed amid the pandemic. The credit equaled 70% of qualified wages paid between January 1 and September 30, 2021.

2. Paid Sick and Family Leave Credits

Valid through April 1, 2020, and September 30, 2021, this credit covered up to 80 hours or ten days of employees’ sick leave. This credit covered up to $5,110 in people’s pay, while 2/3 of one’s employees was covered for people caring for sick individuals.

Tax Credits vs Tax Deductions

Tax credits are dollar-for-dollar reductions in one’s tax liability, while tax reductions lower one’s taxable income. Credits can potentially result in refunds, while the reduction depends on one’s tax bracket. While both can reduce one’s overall taxes, tax credits can help you earn additional funds, mainly if the credit is refundable.

How to Claim Tax Credits for Small Businesses

Businesses should complete the proper forms when claiming credits according to their intent. The filing process will affect one’s general business tax credit. Most of the credits can be claimed upon receipt of tax returns.

Claim Tax Credits for Small Businesses

Companies that want to lower their overall tax bill should take advantage of tax credits. Consult with a CPA professional to learn which credits you qualify for and how to make the most of them. Sign up today to learn more.

FAQs

How much can a small business write off on taxes?

The amount would depend on several factors, such as qualified reductions, tax credits, and tax brackets. Proper documentation should be provided to justify these claims.

Do small business owners get tax refunds?

Yes, refunds are possible if people qualify for tax credits or other deductions. The eligibility criteria depend on the tax benefit.

What tax benefits do small businesses have?

Small businesses are eligible for various tax credits, and if they take advantage of small business tax loopholes, they can lower their overall tax liability.

Is there a tax credit for starting your own business?

No, but you can get credits for starting retirement plan contributions to employees and hiring certain targeted groups for your business. You can also earn credits for research expenses.

What is the 20% tax deduction for small businesses?

Pass-through owners who qualify to reduce 20% of their net business income from income taxes receive a 20% tax reduction.

What is the $7,000 tax credit?

The EITC can help companies earn up to $7,000 in tax credits but must satisfy the requirements.

How to get the biggest tax refund when self-employed?

You can maximize your retirement plan contributions to get the largest refund according to your tax bracket.

How much can an LLC write off?

This would depend on the company size and revenue for the tax year.