Tax time can be stressful for small business owners. However, the more knowledge you have about your tax situation, the less likely you are to leave money on the table. Taking advantage of small business tax credits can be a good opportunity to make the most of your tax return.
Below, we’ll discuss common tax credits available for small businesses; explain how to claim the credits; highlight the differences between tax credits and deductions; and answer some frequently asked questions to help optimize your tax filing.
- There are a variety of small business tax credits available for businesses to take advantage of, ranging from providing employees paid family and medical leave, to increasing access for people with disabilities.
- You can claim business tax credits by filling out the appropriate forms for the credits for which your business qualifies.
- Tax credits are different from tax deductions. For instance, tax credits directly reduce how much tax a business owes dollar for dollar, whereas tax deductions are business expenses that decrease how much of a business’s income is taxable.
- Consult with your accountant or tax preparer about tax credits your business might qualify for.
Small Business Tax Credits
There are a number of tax credits that small businesses could potentially qualify for. Here are a few of the more common options.
Paying Family and Medical Leave for Employees
You would use Form 8994 to calculate tax credit for providing employees with paid family leave and medical leave for tax years post-2017. An employer must offer qualifying employees a minimum of two weeks of paid family and medical leave yearly, among other criteria. The credit offers between 12.5% and 25% of certain wages that were paid to qualifying employees during the time off. The credit can be taken within three years of the due date of your return.
Small Employer Health Insurance Premiums
As part of the Affordable Care Act (ACA), or Obamacare, tax credit is available for qualifying businesses that offer employees health insurance premiums for tax years following 2009. Employers can use Form 8941 to calculate the amount of the credit. Tax years post-2013 only offer the credit for a period of two consecutive tax years.
In order to be a qualifying small employer, during the tax year, the business must have paid employee health insurance coverage premiums abiding by a qualifying arrangement, have fewer than 25 full-time equivalent employees, and have paid average annual wages less than $56,000 per full-time employee.
Research and Development Tax Credit
This tax credit was intended to incentivize innovative research and development (R&D). Qualified research activities and basic research payments can both be claimed toward the tax credit. These pursuits may include:
- The development of novel products
- Improving current products
- Creating or bettering current software and prototypes
To calculate and claim credit for increasing R&D activities, businesses can file Form 6765. If you think your business may qualify, consult with your tax preparer because this credit involves various parts, and could involve different forms depending on your business classification.
It’s important to keep detailed documentation of efforts associated with the R&D tax credit. Keep track of records related to the activity, such as employee payroll, costs, invoices, receipts, relevant contracts, blueprints, or notes.
Disabled Access Credit
This credit is for small businesses that spend money on creating access for those with disabilities. Form 8826 provides details on qualifying costs. Qualifying small businesses can use the credit every year that costs are incurred toward increasing access.
Examples of eligible expenditures include:
- Removing barriers that keep a business from being accessible to those with disabilities
- Increasing accessibility for those with hearing or visual impairments
- Getting or adapting equipment to accommodate individuals with disabilities
How To Claim Small Business Tax Credits
To take a general business credit, fill out the appropriate credit form provided by the IRS for business credits applicable to your current year. You will likely need to also fill out Form 3800. Any accumulation of business credits from earlier years coupled with any current business credits will create your current year’s worth of general business credit.
Speak with your accountant or tax preparer about which tax credits your small business may qualify for and the requirements to claim the credits.
Tax Credits vs. Deductions
To give you a clearer picture when filing, here is a table that shows the differences between tax credits and deductions.
|Tax Credits||Tax Deductions|
|How It Works||Directly decreases the amount of tax a business owes||Business expenses that can lower the amount of taxable income|
|Reduction Amount||Reduces taxes dollar for dollar||Reduces how much of a business’s income is taxable|
|Tax Rates||Is not dependent on a business’s tax rate||Is dependent on a business’s tax rate|
|Value Discrepancies||Credits have the same value for all businesses that can redeem the full credit||Dependent on tax liability and marginal tax rate; more useful for businesses in higher tax brackets|
|Ability to Reduce Taxable Income Below Zero||Usually nonrefundable||Once limit is met, any additional deductions can’t be used|
Tax Credits vs. Tax Deductions Explained
- Tax credits directly decrease the amount of tax a small business owes by a dollar-for-dollar amount. For example, a $200 tax credit will decrease a business’s tax bill by $200.
- Tax deductions don’t have as much of a direct impact on a filer’s tax liability as tax credits. Instead, they lower your taxable income, and how much money you save depends on your tax rate.
- While a tax credit gives the same benefit to all businesses that can claim the full amount, how much a business benefits from a tax deduction depends on the business’s tax liability and marginal tax rate. Businesses in higher tax brackets benefit the most.
- Tax credits usually can’t decrease a business’s tax liability less than zero; however, there are some exceptions in which the business can receive funds back. Deductions can’t make taxable income lower than zero.
Frequently Asked Questions (FAQs)
What kind of research is eligible for a small business tax credit?
To qualify for the research and development tax credit, a business must be spending on projects based in hard sciences such as engineering, computer science, and chemistry. There are different types projects that could potentially qualify for the credit, such as:
- The creation of new products
- Improving current products or processes
- Building or bettering current prototypes and software
How do you get a tax ID number for your small business?
How long should you keep tax records for your small business?
It depends on the purpose of the document. Typically, records must be kept for the duration of the period of limitations for the relevant tax return. The IRS provides details about this period.
What is the tax rate for small businesses?
How you will be taxed as a small business depends on how your entity is structured. The current tax rate for C-corporations is 21%. If your business is set up as a sole proprietorship, partnership, or S-corporation, then you will be taxed according to your personal income tax rate.
IRS. “Instructions for Form 8994.” Page 1.
Tax Policy Center. "Briefing Book. What Are Tax Credits and How Do They Differ From Tax Deductions?"
Center for Budget and Policy Priorities. "Policy Basics: Tax Exemptions, Deductions, and Credits."