Tax Credits Commonly Available to Small Businesses

Tax Credits Commonly Available to Small Businesses

Tax Credits Commonly Available to Small Businesses

Whether you’re an entrepreneur starting a business, or the owner of an established business, every dollar counts. Tax credits can help your business save money by reducing the amount of money you pay in income taxes. Here are the most popular federal tax credits for small businesses.

General Business Tax Credits For Small Business

First, let’s just explain what tax credits are. Tax credits are a dollar-for-dollar reduction in the amount of taxes you owe. They are often referred to as “top line” deductions because they directly reduce your tax bill. 

For example if you owe $2000 in taxes and you get a tax credit of $1500, you only owe $500.

As you’ll see in a moment with specific tax credits, these tax breaks are designed for specific types of business expenses, often as incentives for businesses to offer certain employee benefits, or invest in renewable energy, for example. Sometimes they will apply to someone who is self-employed and has no employees (a freelancer, for example) but not always. 

Tax deductions, by contrast, reduce your amount of taxable income. Let’s say you have $500 in business tax deductions and your business income is $2000. You subtract $500 from $2000 which leaves you with taxable income of $1500. You then owe taxes on that $1500 at your current tax rate.

Tax deductions are also valuable, so don’t overlook them. For example, deducting the interest on a small business loan helps lower your cost when you borrow.

Many entrepreneurs don’t pay taxes directly on their business. Instead, business taxes flow through to their individual tax returns. While you want your business to be profitable, reducing the taxable income of your business can often reduce your personal tax liability.

Some common tax credits for small businesses include:

  1. Small Business Health Care Tax Credit
  2. Energy Efficiency Tax Credits
  3. Research and Development (R&D) Tax Credit
  4. Work Opportunity Tax Credit
  5. Disabled Access Credit

The General Business Credit (GBC) is not a single tax credit, but refers to a group of tax credits a business may be eligible for. It’s a long list, so we haven’t included all of them here, but you can review the full list on pages 2 and 3 of the Instructions for IRS Form 3800. That list is also helpful because it lists the credits in the order in which they should be claimed if your business is eligible for more than one. 

  • Work opportunity credit (Form 5884) 
  • Credit for increasing research activities (Form 6765) 
  • Disabled access credit (Form 8826)
  • Empowerment zone employment credit (Form 8844)
  • Employer social security and Medicare taxes paid on certain employee tips (Form 8846) 
  • New markets credit (Form 8874)
  • Credit for small employer pension plan startup costs (Form 8881)
  • Credit for employer-provided childcare facilities and services (Form 8882)
  • Alternative motor vehicle credit (Form 8910) 
  • Alternative fuel vehicle refueling property credit (Form 8911). 
  • Credit for employer differential wage payments (Form 8932).
  • Qualified plug-in electric drive motor vehicle credit (Form 8936).  
  • Qualified plug-in electric vehicle credit (carryforward only). 
  • Credit for small employer health insurance premiums (Form 8941)
  • Employee retention credit for employers affected by qualified disasters (Form 5884-A)
  • Employer credit for paid family and medical leave (Form 8994) 
  • Credit for auto-enrollment (Form 8881)
  • Qualified commercial clean vehicle (Form 8936-A)

When it comes to General Business Credits, an eligible small business is a corporation whose stock is not publicly traded, a partnership, or sole proprietorship with average annual gross receipts for the 3-tax-year period preceding the tax year of the credit of $50 million or less. (Returns and allowances made during the year reduce gross receipts.) You may see additional requirements to claim specific credits. 

You’ll file IRS Form 3800 to claim these credits, but you must still maintain a separate record of each one. 

Here are a few of the most popular tax credits available to many small businesses: 

Health Care Tax Credits For Small Business

If you run a small business, you may be able to take advantage of the Small Business Health Care Tax Credit. 

Eligible employers must generally have fewer than 25 full-time equivalent (FTE) employees and cover at least 50% of premiums paid for employee’s coverage. The rules are somewhat complicated, but it can be a very valuable tax credit (and health insurance can be a helpful recruiting tool), so you’ll want to review the instructions for IRS Form 8941 and, ideally, talk with your tax professional. 

A few key points to keep in mind:

  • 25 FTEs does not necessarily equal 25 full-time employees. You could have a larger number of part-time employees that help you remain below the threshold. Here, FTE equals 2080 hours per year and, as the IRS explains, “Any number of part-time employees that work a combined number of hours equal to that of a full-time employee equals one FTE.”
  • Premiums paid for certain employees don’t count. Those include: 
    • Owner of a sole proprietorship
    • Partner in a partnership
    • Shareholder of S Corporation owning more than 2 percent
    • Owner of more than 5 percent of the business or other businesses
    • Family members of the above
  • You paid average annual wages for the tax year of less than $58,000 per FTE. (The IRS provides a worksheet for this calculation.) 
  • You offer a qualified health plan to your employees through a Small Business Health Options Program (SHOP) Marketplace. (There is a limited exception to this requirement.)
  • And since tax year starting in 2014, the credit is only available for a 2-consecutive-tax-year credit period.

Again there are specific requirements you must meet, but it can be well worth exploring this credit if you believe you may qualify. 

Energy-Efficient Tax Credits For Small Business

As part of the Inflation Reduction Act, businesses will be able to receive a tax credit for 30% of the cost of switching to solar power, and small business building owners can receive a tax credit of up to $5 per square foot for certain energy efficiency improvements to lower utility bills. Also, small business owners who use large vehicles like trucks and fans may be eligible for tax credits covering 30% of purchase costs for clean commercial vehicles like electric and fuel cell models. 

Work Opportunity Tax Credit

The Work Opportunity Tax Credit is a credit businesses may claim when they hire a new employee who is in a WOTC Targeted Group, which currently includes

  • Qualified IV-A (“TANF”) recipient; 
  • Qualified Veteran; 
  • Qualified Ex-Felon; 
  • Designated Community Resident; 
  • Vocational Rehabilitation Referral; 
  • Summer Youth Employee; 
  • Supplemental Nutrition Assistance Program (SNAP or “food stamps”) recipient; 
  • Supplemental Security Income (SSI) recipient; 
  • Long-term Family Assistance (Long-term TANF) recipient; and 
  • Qualified Long-term Unemployment recipient. 

The maximum tax credit ranges from $1,200 to $9,600, depending on the employee hired and the length of employment. 

Note that the job applicant and the employer must complete a pre-screening notice (Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit) on or before the day the job offer is made. 

Empowerment Zone Employment Credit

The Empowerment Zone Employment Credit is a tax credit for businesses located in Empowerment Zones (EZ) who hire and retain employees who also live in the EZ. (You’ll find a list of EZs in the instructions for IRS Form 8841.) Businesses can earn a credit of up to 20% of the first $15,000 of wages. It doesn’t apply to someone who owns 5% or more of the company stock, and businesses in certain types of businesses don’t apply (such as golf courses or massage parlors). 

FICA Tip Credit

This credit allows certain food and beverage establishments to claim a credit for Social Security and Medicare taxes paid or incurred by the employer on certain employees’ reported tips. (The full name of this credit is “Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips.”) 

Tip: Payroll solutions provider Paychex offers a free FICA Tip Credit Savings Calculator

Qualified Small Business R&D Tax Credit

Small businesses may be eligible to get a tax credit for certain research activities. IRC 41, Credit for Increasing Research Activities, allows taxpayers a credit against income tax for increasing research activities (“research credit”). There is an election designed to benefit an eligible startup that has little or no income tax liability by allowing it to take a payroll tax credit. 

The qualified small business payroll tax credit for increasing research activities has increased recently. For tax years beginning before January 1, 2023, a qualified small business may elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit. The Inflation Reduction Act of 2022 (the IRA) increases the election amount to $500,000 for tax years beginning after December 31, 2022.

Disabled Access Credit

Small businesses that incur expenses related to providing access to persons with disabilities, including customers or employees, may be eligible for The Disabled Access Credit provides a non-refundable credit of 50% of eligible expenses up to $5000. 

To be eligible, a small business must earn $1 million or less or have no more than 30 full time employees in the previous year; but they can take the credit every year they pay for these types of expenses. You’ll find more detailed information about eligible expenses in IRS Form 8826

Employee Retention Credit

In order to help employers continue to pay employees after a natural disaster, this credit offers a credit equal to 40% of up to $6,000 of qualified wages paid to or incurred for each eligible employee if an eligible employer continues to pay or incur wages after the employer’s business became inoperable because of damage from a qualifying major disaster.

The Coronavirus ERC is a refundable tax credit that may be available to businesses that continued to pay employees while shut down due to the COVID-19 pandemic or had significant declines in gross receipts from March 13, 2020 to Dec. 31, 2021. Eligible employers can claim the ERC on an original or adjusted employment tax return for a period within those dates. Eligible businesses are continuing to claim this credit by filing amended forms. 

However, the IRS is warning business owners about ERC scams. It urges business owners to carefully review the guidelines as some firms are encouraging ineligible businesses to file for the credit and charging a fee for assisting them. 

Credit For Small Employer Pension Plan Startup Costs & Auto Enrollment

Small business employers who qualify may be eligible for a tax credit of up to $5,000, for three years, for the costs of starting a qualified retirement plan, such as a 401(k) plan, SEP, or SIMPLE IRA, and can include the cost of educating employees about the plan. The credit is for 50% of eligible startup costs up to $500, plus the $250 per non-highly compensated employee eligible to participate, capped at $5,000.

Closely related to this is a credit for setting up an auto-enrollment plan for your qualified retirement plan. This credit is $500 for the first tax year that an eligible employer first includes an eligible automatic contribution arrangement (under section 414(w)(3)) in an eligible employer plan. You can also claim the same credit of $500 for each of the following 2 tax years, provided that you continue to maintain the arrangement at any time during the applicable tax year.

Credit For Employer-Provided Childcare Facilities And Services

Offering childcare for your employees can be a tremendous benefit, but it’s not cheap. This tax credit can help offset some of that cost. The credit covers 25% of the qualified childcare facility expenditures plus 10% of the qualified childcare resource and referral expenditures paid or incurred during the tax year. The maximum amount of the credit is $150,000 per tax year.

Expenses may include acquiring or renovating a property, operating costs (including the cost of training employees), and can even include costs of a contract with a qualified childcare facility to provide childcare services to employees. But it can’t be located in the principal residence of the taxpayer or any employees. See Form 8882 has more information.

Credit For Employer Differential Wage Payments 

This tax credit is available to employers who continue to pay wages to employees while they are serving on active military duty for at least 30 days.  The Credit for Employer Differential Wage Payments is 20% of up to $20,000 of differential wage payments paid to each qualified employee during the tax year. (Note you can’t claim the ERC for the same wages paid to the employee.) 

Employer Credit For Paid Family And Medical Leave

This tax credit is for employers who provide paid family and medical leave to their employees. If eligible, employers can claim a credit equal to 12.5% of the wages paid during the leave period, increasing to a maximum of 25% if the employer pays employees at least 50% of their regular wages during the leave period.

There are some restrictions that apply, including a written policy for leave that meets certain requirements (including at least two weeks of paid family and medical leave for full-time employees); employees must have been working for the employer for at last one year; and there is a cap on eligible employee wages. You’ll find details on the IRS website, or talk to your CPA or tax professional. Payroll Solutions providers may offer information about various payroll-related tax credits.

FAQ on Small Business Tax Credits

How Can Small Businesses Claim Tax Credits?

In many cases, small businesses will claim tax credits on IRS Form 3800. Some tax credits may require additional forms, however for smaller businesses Form 3800 will often be sufficient. However, the IRS cautions business owners that they must keep documentation of each credit they claim. 

Are Tax Credits Refundable?

Many of the tax credits mentioned here are refundable, which means that even if the credit is larger than the amount owed for the year, the taxpayer can receive a refund for the excess amount. However, the General Business Credit is limited and can generally offset up to 75% of the taxpayer liability. Credits may be carried back for one year, then carried forward for up to twenty consecutive years. 

For that reason it’s important to worth with a qualified tax professional ensure you are taking advantage of the maximum credits available.

Can Small Businesses Claim Tax Credits For Previous Years?

If your business missed out on a tax credit and you’ve already filed your tax return, you may be able to amend a previous return within a specific time frame. This will incur additional tax preparation fees, so you’ll want to make sure it is worth it.

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