Small Business Tax Deductions & Credits
If you are looking for a way to help minimize the costs of running a business and get a little money back at tax time there are very good chances with small business tax credits.
Small businesses are entitled to claim tax credits that reduce the amount of tax you pay to the government. Businesses of all sizes usually file for tax credits and tax deductions as part of their annual tax filing process.
As tax and accounting advisors, we’re breaking down everything you need to know about small business tax credits, including:
• What are tax credits and why do they exist?
• What’s the difference between tax credits and tax deductions?
• A comprehensive list of small business tax credits you need to know about
This article will help small business owners understand tax credits and discover which ones are relevant for your business.
What Are Small Business Tax Credits and Why Do They Exist?
The U.S. government rewards individuals and businesses with tax credits for small and large acts that contribute to strengthening the economy, fighting climate change and employing and improving people’s lives.
Tax credits are offered to businesses as incentives for activities that benefit employees, specific industries and society. Some businesses like pharmacies and pharmaceuticals companies can claim tax credits for doing research and development, providing benefits for their employees and buying electric vehicles.
It’s important to be aware of tax credits for which your small business may be eligible because they can make a dramatic difference to your bottom line. That’s because tax credits cut the actual tax you pay as a small business owner.
In fact, small business tax credits are dollar for dollar which means every dollar of credit cuts your tax by a full dollar. This is huge for small businesses because it allows you to recover some of the costs of running a business and keep much-needed capital that will allow you to grow and prosper.
For example, if you owe $30,000 in small business taxes, but you claim a $10,000 tax credit, you can subtract that full amount from your tax bill. Your new tax bill would be $20,000. Small business tax credits add up quickly!
It literally pays to pay attention to the way small business tax credits—and your very own business change. This is an activity you and your tax professional will want to schedule in every year at tax time.
What’s the Difference between a Tax Deduction and a Tax Credit?
You’ve probably heard about tax deductions. As a small business owner, you receive a tax deduction for every business-related expense you claim on your taxes, including rent, supplies, travel and business-related subscriptions.
Deductions cut your taxable income, so every dollar of deductions will cut your total tax by a percentage of that deduction depending on your tax bracket. Tax deductions become more valuable as your taxable income rises. For example, if you’re in the 15% bracket, every dollar you deduct cuts your tax by 15 cents. If you’re in the 35% bracket, that same dollar deduction cuts your tax by 35 cents.
In contrast, tax credits are like turbocharged tax deductions because every dollar of credit cuts your tax by a full dollar. Plus, tax credits are more valuable for taxpayers in lower brackets. If you’re in the 35% bracket, you need $2,857 in deductions to equal a $1,000 credit. In the 15% bracket, you’d need a whopping $6,667 in deductions to equal that $1,000 credit.
14 Tax Credits You Should Know About
Here is a list of tax credits your business may be eligible for. This comprehensive compilation does not include all small business tax credit available, but these are the ones that many small companies should be aware of and potentially pursue.
Remember, small business tax credits have limits and qualifications that your business must meet to receive the credit. Indicate the ones that seem like a good fit and make a note to discuss with a trusted tax professional.
1. GENERAL BUSINESS TAX CREDIT
This catch-all tax credit is comprised of a number of individual tax credits designed to motivate business owners to undertake specific activities, such as purchase qualified electric vehicles, get into new markets and retain employees. Some of these tax credits are covered below.
You’ll need to fill out a separate form for each of these credits and then you can add them all up on the General Business Tax Credit—Form 3800.
2. CREDIT FOR SMALL EMPLOYER HEALTH INSURANCE PREMIUMS
If you want to provide health insurance coverage to your employees—and get a tax credit in the process—this one is for you. According to the IRS, the credit can be up to 50% of the premiums you paid for health insurance coverage under a qualifying arrangement, or, if you’re an eligible tax-exempt employer, up to 35% of the premiums you paid. Either way, it’s a significant tax credit.
You’re eligible if:
• Paid premiums for employee health insurance coverage that you purchased through the SHOP Marketplace (for employers with fewer than 50 full-time employees) under a qualifying arrangement.
• You had fewer than 25 full-time employees for the tax year
• You paid average annual wages for the tax year of less than $54,000. (This is the 2018 number; it’s subject to change every year.)
For more information about the Small Business Health Care Credit, visit the Taxpayer Advocate Service. And you can fill out a claim on Form 8941.
3. CREDIT FOR PAID FAMILY AND MEDICAL LEAVE
This tax credit was authorized by congress in 2017 to motivate small business owners to provide paid leave to their employees covered by the Family and Medical Leave Act. It provides certain employees up to 12 weeks of unpaid, job-protected leave, plus access to group health benefits, every year.
Reasons for a leave include the birth of a child or a health emergency in the family. The IRS says that eligible employers may claim the credit, which is equal to a percentage of wages they pay to qualifying employees while they’re on family and medical leave.
Small business owners are eligible for this tax credit if they have a written policy that meets the requirements, including providing at least two weeks of paid family and medical leave every year to all qualifying employees who work full time. (This is prorated for part-time employees.) The paid leave should also not be less than 50% of the wages normally paid to the employee.
Qualifying employees must have worked at least a year for the employer and earned less than $72,000 in the previous year. The tax credit ranges from 12.5% to 25% of the wages paid to qualifying employees on family or medical leave for up to 12 weeks, depending on the amount of the employee’s normal wages.
The credit is effective for wages paid in taxable years of the employer beginning after December 31, 2017, and it is not available for wages paid in taxable years beginning after December 31, 2019.
For more information about this tax credit, see the IRS Employer Credit for Paid Family and Medical Leave FAQs. You can enter a claim on Form 8994.
4. ALTERNATIVE FUEL CREDITS
These niche tax credits are calculated from the costs associated with the production of alcohol-based fuels such as methanol and ethanol and other alternative fuels including biodiesel or renewable diesel. The idea behind it is to encourage business owners to invest in other fuels to reduce the U.S. dependence on imported oil.
Please note that they will only apply if you happen to be involved in the production of fuels, not the consumption of them.
You can use Forms 8849, 4136, 6478 or 8864 to make a claim or a refund for alcohol, biodiesel or renewable diesel or alternative fuel used to produce a mixture.
5. ALTERNATIVE MOTOR VEHICLE CREDIT
Take advantage of a tax credit of up to $8,000 that encourages the purchase of an alternative fuel source vehicle. This does not apply to hybrids or electric vehicles since they use conventional fuel sources.
Currently the IRS only recognizes a few vehicles, including the Mercedes-Benz 2012 F-Cell and cars from the Honda FCX Clarity series, all of which use hydrogen fuel-cell technology. You can claim this tax credit on Form 8910.
Related tax credits include:
• Alternative Fuel Vehicle Refueling Property Credit (Form 8911)
• Qualified Electric Vehicle Credit (Form 8834)
6. DISABLED ACCESS CREDIT
This tax credit encourages businesses to make their offices and other facilities fully accessible to people with disabilities. Some of the upgrades include installing ramps, improving storage and display units, upgrading restrooms and providing text in braille.
Your small business is eligible for this credit if you have a total revenue of $1 million or less or have 30 or fewer full-time employees. You can cover up to 50% of disabled access expenditures, ranging from $250 to $10,000. The maximum credit available is $5,000 on $10,000 of expenditures.
Claim this credit on Form 8826.
7. CREDIT FOR EMPLOYER-PROVIDED CHILD CARE FACILITIES AND SERVICES
Here’s a tax credit for businesses that directly pay the child care expenses for its employees or help their employees secure child care. The credit is for 25% of expenses, plus 10% of child care resource and referral expenditures, up to $150,000 a year.
Fun fact: Employees can actually realize a greater benefit from the Employer-provided Child Care Tax Credit than they would from the Child and Dependent Care Tax Credit they could claim on their own personal tax return. Let’s say an employee pays $3,000 for childcare, the maximum credit they can take on their return is $1,050 ($3,000 x 35%). The employee effectively paid $1,950 for child-care services ($3,000 – $1,050 = $1,950).
If the employer pays $3,000 to a child-care facility for an employee’s child, the employee saves the $1,950. It’s important to note that the employer is not subject to the $3,000 limitation per child when calculating the credit. On average the full-time care for a child is $5,973. Thus, savings for most employees would be substantial, although child care payments made in excess of $5,000 are added to the employee’s gross wages.
Keep in mind if you are incorporated and an employee of the corporation you could also be eligible for the same benefits that you offer to the rest of your employees.
Claim this tax credit on Form 8882.
8. REHABILITATION, ENERGY AND REFORESTATION INVESTMENTS CREDIT
This tax credit is for investments in reforestation, building rehabilitation and alternative energy property used in business. The credit is generally 10% of expenditures and is limited to $10,000 per year.
Claim this tax credit on Form 3468.
9. QUALIFIED RESEARCH EXPENSES CREDIT / INCREASING RESEARCH ACTIVITIES CREDIT
These small business tax credits are designed to encourage domestic research and development. The calculation of the credit can be very complex, but it can also provide substantial tax savings.
This definition is relatively broad but encompasses activities such as:
• Developing new or improved products, processes or formulas
• Prototype or model development
• Developing or applying for patents
• Certification testing
• Developing new technology
• Environmental testing
• Developing or improving software technologies
• Building or improving manufacturing facilities
• Streamlining internal processes
This credit is open to individuals, partnerships and corporations and can cover up to 20% of expenses. However, only some types of research qualify and sorting out if yours does can be challenging. Check out the instructions for Form 6765 or consult a tax expert to figure out if your research is eligible.
Another thing to note: Small businesses don’t claim this credit directly. You file Form 8974, which offsets up to $250,000 of that small business’ share of Social Security taxes for that year.
10. SMALL EMPLOYER PENSION PLAN STARTUP COSTS CREDIT
This is a small business tax credit designed to offset the costs of starting a pension. The credit is limited to $500—or 50% of your startup costs. You can claim it for the first three years of your plan.
To be eligible, your business must:
• Have fewer than 100 employees who receive at least $5,000 in compensation
• NOT have had an existing 401(k) or other qualifying retirement plan for the past 3 years
To claim this tax credit, fill out Form 8881.
11. WORK OPPORTUNITY CREDIT
This is a tax credit available to businesses that hire employees who have traditionally faced significant barriers to employment. Many job seekers experience one or more barriers to employment during their careers. Although this makes finding or keeping a job more difficult, it’s not impossible. Some barriers, such as lack of transportation, are temporary and easier to address than others like education, child-care or disabilities.
There are 10 categories of eligible workers, including:
• Ex-felons
• Unemployed veterans, including disabled veterans
• Long-term family assistance recipients
• Summer youth employees living in Empowerment Zones
The credits are calculated based on wages paid to the employees and can provide up to a $9,000 savings over two years.
Our firm can help you optimize the Form 5884 tax credit.
12. EMPOWERMENT ZONE AND RENEWAL COMMUNITY EMPLOYMENT CREDIT
Here’s a tax credit for businesses that hire someone who lives and works in a low-income area. The U.S. Department of Housing and Urban Development created Empowerment Zones to stimulate development in low-income areas. Visit the HUD website to see the zones.
Qualifying businesses can receive up to $3,000 for each full or part-time employee who lives in an Empowerment Zone. This comprises up to 20% of the first $15,000 in wages.
Claim this tax credit on Form 8844.
13. NEW MARKETS CREDIT
This tax credit supports businesses that invest in Community Development Enterprises (CDEs) and Community Development Financial Institutions (CDFIs), which are organizations that help low-income communities.
Most eligible projects involve acquiring, renovating or building real estate in low-income areas, such as:
• Educational facilities or community centers
• Hospitals or health care facilities
• Industrial buildings that create jobs
• Facilities that serve women, minorities or other under-served communities.
Your project must be located within an area that has a 20% poverty rate or with median family incomes that don’t exceed 80% of the area median income. Here’s a tool that can help you find CDEs and CFDIs.
When you’re ready, file for this tax credit on Form 8874.
14. TAX CUTS AND JOBS ACT
Small business owners filing their 2018 taxes were able to take advantage of new legislation that provided a 20% tax break. One of the features of the Tax Cuts and Jobs Act (TCJA) is a qualified business income deduction. It allows owners of “pass-through” entities, including sole proprietorships, S-corporations and partnerships to deduct up to 20% of their qualified business income.
Although this act is evolving and the IRS has put limits on it, entrepreneurs in any industry may take the 20% deduction if they have taxable income that’s under $157,500 if they’re single or $315,000 if they’re married.
For more information, review the IRS TCJA comparison for businesses.
Conclusion
Claiming a tax credit isn’t a ‘one and done’ activity. It’s something you need to review with your tax professional carefully every year at tax time because your eligibility for certain tax credits will change.
Additionally, some credits expire, new credits come available and a few credits are gradually phased out. For example, you can claim a tax credit for a business purchase or activity only for the year that you started using a product (e.g. electric vehicle) or doing the activity (i.e. research and development), not every year into perpetuity. Conversely, as your business evolves, you may be able to claim tax credits that were not available previously.
Small business tax credits can be hard to parse and challenging to keep track of, but they are worth every minute of your time—or the expense of a qualified tax professional to review the ones for which your business is eligible.
One way to make things easier at tax time is to have all of your accounting numbers in order. Many cloud accounting solutions categorize and present small business financial information into tax-ready accounting reports.
Organization and investigation into small business tax credits go a long way!