Let’s talk about tax credits – what they are, how they differ from deductions, and which can benefit your small business.
What are tax credits?
A tax credit is a dollar-for-dollar reduction of one’s tax liability, reducing the amount of tax owed. So, a tax credit of $300 lowers your bill by $300.
Tax deductions work differently. Let’s see how tax credits and tax deductions differ.
How do tax credits differ from tax deductions?
Unlike tax credits, which are dollar-for-dollar reductions in taxes, tax deductions decrease one’s taxable income. That means only a percentage of each dollar deducted is taken off your income tax. The percentage depends on your tax bracket and the rate at which your income is taxed.
How do you know which tax credits apply to your business?
General business tax credits are calculated individually from a list of tax credits published by the IRS. Each one requires its own form. Once those are filled out, they are tallied. Once the general business tax credit for the year is determined, it is filed on Form 3800 with your tax return.
Now let’s discuss some tax credits that benefit small businesses.
What are some tax credits that benefit small businesses?
1. Family and Medical Leave Credit (FMLC)
Family and medical leave is taken when an employee must be away from work due to an event such as:
- the birth of a baby
- a severe illness of an immediate family member
- a serious health condition that prevents the employee from working
The tax credit for this type of leave is applicable when the employer:
- has a written policy in place stating they will provide family and medical leave.
- provides paid leave to employees for family or health-related reasons for at least two weeks in a given year.
- pays a minimum of half the employee’s earnings
The employee must have been on the payroll for at least one year for an employer to claim the credit, which is between 12.5 and 25 percent of the employee’s pay.
You will use IRS Form 8994, the Employer Credit for Paid Family and Medical Leave to claim this credit.
2. Child Care Credit
This credit is part of the general business credit. It may be claimed any time within three years from the due date of your return on either an original or amended return. The credit is 25 percent of the qualified childcare facility expenditures plus 10 percent of the qualified childcare resource and referral expenditures paid or incurred during the tax year, limited to $150,000 per tax year.
Qualified expenditures are:
- The cost of acquiring, building, or expanding a property to be used as part of a qualified childcare facility, is the depreciable (or amortizable) property and is not part of the principal residence of the business owner or any employee.
- Operating expenses of a qualified childcare facility of the taxpayer
- The expense paid to a qualified childcare facility that provides childcare to employees.
For this tax credit, fill out IRS Form 8882, Credit for Employer-Provided Child Care Facilities and Services.
3. Health Insurance Credit
Employers who pay health insurance premiums for employees can redeem a tax credit for up to 50 percent of those expenses. However, specific criteria must be met. For example, this credit only applies to companies with less than 25 full-time employees. The employer must pay at least half the employees’ health insurance premiums. Further, the average payroll cannot be more than $56,000 (as of 2022). Also, remember that your business must purchase health coverage through the Small Business Health Options (SHOP) program.
If your business meets these criteria (and all others required by the IRS), use Form 8941, Credit for Small Employer Health Insurance Premiums.
4. Employee Pension Plan Credit
The Employee Pension Plan Credit is worth up to $500, or 50 percent of your business startup costs. It can be claimed for the first three years of your plan. To qualify for this credit, your company must have fewer than 100 employees, each receiving a minimum of $5,000 in compensation. You can’t have had a 401(k) or other qualifying retirement plan for the previous three years. Lastly, you must plan to start a pension plan for your employees.
To claim this credit, use IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs.
5. New Clean Vehicle Credit
This tax credit applies to plug-in electric vehicles (EV) or fuel cell vehicles (FCV). You could receive a credit of up to $7,500 for either of these types of cars. The Inflation Reduction Act of 2022 changed the rules for this credit for vehicles purchased from 2023 to 2032.
To qualify, the vehicle must be for your own use and not for resale and must be used in the United States. Further, your modified adjusted gross income (AGI) may not exceed $150,000. The type of vehicle the credit applies to can be found on the IRS website. (Note: battery and vehicle weight specifics and other qualifying criteria exist.)
To claim the credit, file Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit (Including Qualified Two-Wheeled Plug-in Electric Vehicles), with your tax return. You will need to provide your vehicle’s VIN.
6. Disabled Access Credit
You might be eligible for this credit if you spent money making your business more accessible to people with disabilities. To determine the official IRS definition of “accessible” which is broad, consult the instructions for IRS Form 8826. That is where you will find qualifying expenses.
The credit covers 50 percent of expenses up to $10,250 after the first $250. The maximum tax credit is $5,000. To claim this credit, use IRS Form 8826, Disabled Access Credit.
7. Work Opportunity Tax Credit (WOTC)
This credit is targeted at employers who hire individuals from specific groups, including (but not limited to):
- Summer youth employees
- SNAP recipients
- SSI recipients
- Long-term unemployment recipients
The WOTC is a one-time tax credit for newly hired individuals. To claim this credit, fill out IRS Form 8850, Pre-screening Notice, and Certification Request.
Of course, you can discuss these and many other tax credits that may benefit your small business with your qualified accountant or CPA.