Tax credits can be a powerful tax planning tool to help businesses of all sizes. They work by allowing businesses to reduce the amount of tax they owe by reducing tax liability.
As the tax season approaches, you may feel overwhelmed if you’re a small business owner who is attempting to make sense of the complex codes and regulations. But don’t stress—it’s not as intimidating as it seems! A great place to start when filing your taxes this year is by looking at all of the credits for which your business might be eligible. Tax credits can offer tangible savings because they directly reduce what you owe, dollar-for-dollar rather than reducing your taxable income like deductions do. So, let’s explore some of the most popular tax credits currently available and how they could help save your company money this year.
What is a tax credit?
A tax credit is a form of tax relief that enables taxpayers to reduce their overall tax liability. It’s often used to incentivize beneficial behaviors, like investing in renewable energy and offsetting tax liabilities. This type of tax benefit is especially valuable for startups, as it helps them alleviate the burden of large tax payments and aids in the preservation of capital.
Additionally, tax credits can provide invaluable tax relief for small business expenses related to wages, research and development, health care costs and more. Tax credits can help startups cover upfront costs when launching a business or extra expenses incurred over the course of running one.
A tax credit can also help small business owners streamline their tax preparations by enabling them to itemize deductions without having to detail all expenses – they have to note only state or federal tax credits.
Many tax credits are flexible as well and may be applied towards both past and future taxes owed. These types of credits are especially helpful for businesses experiencing losses, as they help business owners offset those losses with saved tax payments from previous years.
Depending on the type of tax credit you qualify for, each credit has its own eligibility requirements – but all tax credits provide a financial benefit, regardless of whether you’re an individual taxpayer or business owner.
Tax credits are not just limited to income tax; there are other types of tax credit available which may provide even greater tax savings. For example, the federal tax credit for research and development can help businesses that are heavily invested in innovation to reduce their tax bill.
Similarly, tax credits are also available for energy-efficient upgrades and investments in renewable or alternative energy sources. This also highlights the importance of environmental accounting.
Many tax credits can be used to reduce the amount that business owners must pay in taxes on their income tax returns. Read on for common tax credit examples.
Refundable tax credits
A tax credit is an amount of money that a taxpayer may subtract from their tax obligation. Refundable tax credits exceed the tax liability, meaning that any remaining amount is applied directly to the taxpayer. Refundable tax credits can be claimed by businesses even when their tax liabilities have been reduced to zero. Two prime examples of refundable tax credits include the Family and Medical Leave Act (FMLA) credit for small businesses and the Employee Retention Credit (ERTC) provided by IRS Form 8994.
The FMLA provides job protection to those who need time off work for certain events such as illness, military deployment or to care for a new child and it includes tax credits to offset the cost of providing family leave policies. The FMLA also makes it possible for employees who take qualifying leave under the Act to receive up to 12 weeks of partially paid leave and still remain a part of the same health plan.
The ERTC allows eligible employers to receive an up-front tax credit worth 50% of wages paid to employees during the COVID-19 pandemic. Eligible employers filing Form 8994 can also claim Paid Family and Medical Leave Credit by providing workers with at least two weeks of paid family and medical leave annually. Both tax credits provide critical financial relief to those businesses and individuals who qualify them.
Research & development tax credits
Research and development (R&D) tax credits are government initiatives aimed at encouraging research, technological innovations, and other advancements. Through these credits, businesses can be rewarded for the expenses incurred in R&D activities. These incentives can also allow businesses to offset some of their research costs or reduce their taxable income.
In the United States, research activities that qualify for a federal research credit include:
- Research conducted in the US on new or updated products and processes
- Research done with the intent to increase efficiency/function of existing products/processes
- Research done with the goal of developing new technologies, ideas and software related to this research
Companies should ensure that they meet all necessary criteria before applying for an R&D tax credit. Once these criteria have been met, companies can significantly reduce their annual tax burden.
The United States offers several research and development tax credits. The Research Tax Credit (R&D Credit) incentivizes research in technological advancement. The Renewable Electricity Production Tax Credit encourages electricity production from renewable sources. The Work Opportunity Tax Credit (WOTC) provides a tax benefit for businesses with 25 or fewer employees who hire target groups of unemployed individuals.
Tax incentives like the WOTC can help businesses mitigate financial losses when hiring employees from specified target groups; this is especially beneficial to startups seeking to build a diverse and talented team on a tighter budget. The US also offers research grants to small businesses partnered with universities on research projects.
Other tax credits
Tax credits are an exciting tax planning tool for startups and small businesses alike. The IRS outlines tax credits that are relevant to startups and small businesses in section 38 of the Internal Revenue Code (IRC). Some tax credits of note include the Small Business Health Care Tax Credit and the Research & Development Tax Credit. The latter can be claimed by filing Form 4562 with a tax return, which allows qualifying businesses to take up to 6.5 times their research expenditures as tax credits each year.
Furthermore, form 4562, Depreciation and Amortization, is an important tax form to understand in this context. Form 4562 allows businesses to take tax deductions on certain assets over time through depreciation instead of all at once, helping to decrease taxes while managing cash flow. Startups should be sure to consult with a tax expert regarding these tax credit opportunities to make sure they’re receiving the best deal possible.
It is important for business owners to research what tax credits are available and how they can benefit their business in order to maximize potential savings through proper tax planning.
Start-ups and small businesses may be eligible for tax credits beneficial to their operations. One tax credit commonly taken advantage of is the Section 179 deduction, which allows businesses to deduct certain expenses that were made during the tax year. The deductions can add up quickly for small business owners when combined with other tax credits due to the size of these investments. Deductions can also become available when payments are made to qualifying advisers or employees from start-up companies.
Other less well-known tax credits include those available for employing veterans or vocational students, hiring ex-felons, creating low-emission vehicles, conducting energy efficient building renovations, providing childcare services and investing in renewable energy projects.
As a small business owner, it’s important to be aware of the tax credits you may be eligible for. These can save you thousands of dollars come tax time, so it’s well worth doing your research and taking advantage of them if possible. Some common tax credits available to small businesses include the Research and Development Tax Credit and The Work Opportunity Tax Credit.
If you’re not sure which credits you’re eligible for, our team of experts can help you navigate the complex world of taxes and take advantage of every opportunity available to you.