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Tax Credits for Small Businesses

tax credits for small business

Did you know that small-business tax credits can be more powerful than tax deductions? Sure, claiming deductions reduces taxable income and helps you save money. That said, a small-business tax credit can directly reduce your tax bill. For example, if a sole proprietor makes $110,000 of revenue but is able to deduct $40,000 as expenses, their taxes will be calculated based on $70,000 instead of the full $110,000. A tax credit, on the other hand, reduces the tax bill on a dollar-for-dollar basis, directly subtracting money from your tax bill. 

This is why small-business tax credits are so valuable — they literally put money back into your business. How do you get a small-business tax credit? It’s pretty simple: if you engage in certain types of activities that the government deems helpful to the economy or society as a whole, you can get rewarded with small-business tax credits. Let’s take a look at five popular ones you could be eligible for:

Alternative Energy Tax Credit for Small Businesses

The Business Energy Investment Tax Credit gives small businesses credit for purchasing or implementing energy-saving activities, such as fuel cells and wind and solar energy. Getting equipment to make your business more energy-efficient or more environmentally friendly is a very popular way to save on taxes. In order to qualify, your small business must own or have built the equipment and meet specific quality and performance standards. If your business uses an electric vehicle or has a vehicle that runs on alternative fuel, then you might be able to claim any one of the following small-business tax credits:

  • Biofuel Producer Credit (Form 6478)
  • Biodiesel and Renewable Diesel Fuels Credit (Form 8864)
  • Alternative Fuel Vehicle Refueling Property Credit (Form 8911)
  • Investment Credit for rehabilitation and alternative energy (Form 3468)
  • Qualified Electric Vehicle Credit (Form 8834)

How much are these alternative energy business tax credits worth? While the specific amount of these tax credits can vary based on which credit is claimed, the qualified electric vehicle credit saves a business between $2,500 and $7,500 based on the vehicle’s battery capacity. To get all the specific details on these “green” energy credits, visit the Department of Energy.

Health Care Tax Credit for Small Businesses

Obamacare came with a small business health insurance tax credit to help businesses offer health insurance. To be eligible, a business must have fewer than 25 full-time employees. In addition, the average wages must be less than $54,200 annually. The business must pay at least 50% of its employees’ health insurance premiums using an IRS-qualified health plan. 

Which form do you use for the small business health care tax credit? Look for Form 8941. Even if you are self-employed, you can get a similar deduction for yourself, your spouse and your dependents. This self-employed health insurance deduction can be worth up to your total self-employment income. 

For businesses filling out Form 8941 for the health care tax credit, qualification is for only two consecutive years. In other words, if you’ve already claimed it in 2019 and 2020, you’re no longer eligible for 2021. If you do qualify, the credit is equal to up to 50% of business-paid health insurance premiums.

Research & Development Tax Credit for Small Businesses

Using Form 6765, small businesses can qualify for a tax credit by increasing research and development (R&D) activities. Sole proprietors, partnerships and non-public corporations are eligible. This isn’t just for businesses that do traditional scientific research. “Research” can include:

  • Product development, including new prototypes or models
  • Improving product quality or function
  • Improving business performance, such as manufacturing process

This credit could also be applied to payments to outside researchers or employees who do research. The big thing to remember is that qualified research activities must be able to show a connection between the expenses claimed and the research activity.

How much is the research business tax credit worth? The credit can be for up to 20% of qualified research expenses, up to $250,000 annually. Although science, medical and technology businesses are most often eligible for tax credits like this, many other types of companies can engage in research activities. Just be sure to carefully document your R&D with project notes, process diagrams or lab results.

Employee Retention Credit for Small Businesses

The ERC came as part of the 2020 CARES Act. The goal of this business tax credit was to incentivize employers to keep employees on their payrolls, especially as the pandemic cut into revenues. It started as a fully refundable tax credit for 50% of qualified employee wages (up to $10,000). Effective January 1, 2021, the amount of this business tax credit was increased to 70% of qualified wages, including the cost of health benefits, with a max of $7,000 per employee per quarter. 

More recently with the passage of the American Rescue Plan, the credits are extended through the end of 2021. Meanwhile, employers who receive Paycheck Protection Program (PPP) loans may still qualify for this business tax credit, but not for wages paid for with forgiven PPP proceeds. In addition, group health plan expenses can be considered qualified wages in some circumstances. So, all in all, this is a great tax credit for many small businesses to take advantage of.

Paid Family & Medical Leave Tax Credit for Small Businesses

The next business tax credit that should be on your radar is the paid family and medical leave tax credit. Found on Form 8994, this credit was first authorized back in 2017 to encourage employers to provide paid leave to employees. Keep in mind this isn’t to incentivize vacation time, but rather to allow time for paid leave for life events, such as the birth of a child or a family health emergency.

Are you eligible for the paid family leave tax credit? The answer is yes if you have a written policy that gives full-time employees at least two weeks of paid family and medical leave annually and you pay employees at least 50% of their wages during leave. The program originally ended on December 31, 2020, but Congress extended it, and then the American Rescue Plan extended it yet again through September 30, 2021.

How much is the paid family leave tax credit? It is equal to 12.5% of the wages that are paid to your qualifying employees on family and medical leave during the tax year. This means that the credit increases incrementally if you pay employees more than half of their wages during their leave. 

Is there a maximum credit for paid family leave? Yes; it is 25% of wages for businesses that cover 100% of an employee’s salary during leave.

The only thing to look out for is that if you claim the paid family leave tax credit, the amount of the credit will offset any deduction that you take for employee wages. Overall, this is a very popular business tax credit for employers with fewer than 500 employees.

Small Business Tax Credit Notes

If you’re eligible for more than one business tax credit, submit Form 3800. Although each individual business tax credit requires its own form, this specific form lists each small business tax credit and you can add them all up to calculate your general business tax credit. The only limit you have to keep in mind is as follows:

Add your net income tax and alternative minimum tax. From that total, subtract the greater of either your minimum tax for the year or 25% of the amount of your regular tax bill that’s greater than $25,000.

Some other notable business tax credits that we didn’t touch upon in this post include the Disabled Access Credit on Form 8826, Employer-Provided Childcare Facilities and Services Credit on Form 8882, and Social Security and Medicare Paid on Certain Employee Tips Credit on Form 8846.

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