Small business tax credits and deductions can be confusing. Understanding the differences and how these tax breaks work can help you reduce your taxes. In this article, we will explain which tax credits and tax deductions you may be eligible for, and how to claim these items.
What are tax credits and tax deductions?
Tax credits reduce the amount of tax on your final tax bill on a dollar-for-dollar basis. For example, if your small business owes $10,000 in taxes and you have a $3,000 tax credit, your tax owed is reduced to $7,000.
Tax credits can be refundable or non-refundable. A non-refundable credit can take your tax bill down to zero, and a refundable one can result in a refund.
Tax deductions work a little differently. Instead of directly reducing the amount of taxes you have to pay, they reduce your business's taxable income. You subtract the tax deductions from your business's taxable income to determine your tax liability. The lower your business's taxable income, the less you may have to pay on your taxes.
Types of tax credits available for small businesses
A variety of tax credits are available for small businesses. Check the criteria for each one to see if you qualify, and review your eligibility each year with a tax advisor as tax laws can change. Note that you generally can’t claim both a tax credit and deduction for the same expense.
Most tax credits available to small businesses in the United States are state tax credits, such as California’s small business hiring tax credit, so check your state for details. Some federal tax credits are available too. Check the IRS website to learn more.
Types of tax credits include:
- Employee benefits: These include health care, child care, pension plans, employee leave benefits, and hiring disadvantaged and disabled workers.
- Energy: These credits focus on renewable energy and alternative fuel vehicles.
- Research and development: These are designed to encourage businesses to invest in R&D.
Examples of tax credits and how to claim them
The following are some common tax credits for small businesses. Your tax professional may be able to advise you about tax credits that you may be eligible for.
Research and Development Tax Credit: (Form 6765) Businesses in the medical, technological and science fields are often eligible for this tax credit, though any business that conducts research and development can apply. Acceptable activities are broad and include:
- developing new or improved products
- testing such as certification and environmental
- developing new technologies, software, proprietary patents
- enhancing processes such as quality control
Businesses that are sole proprietors, partnerships, corporations, and LLCs (limited liability companies) can apply. It can cover up to 20% of expenses. It can be complex to claim, so talk to a tax advisor. There are specialty firms that may be able to help you maximize R&D tax credits.
Work Opportunity Tax Credit: (Form 5884) This tax credit is to incentivize small businesses to hire employees from specific backgrounds or those who face significant barriers to employment. The 10 categories of workers eligible for this tax credit include:
- veterans, including disabled veterans
- food stamp (SNAP) recipients
- long-term family assistance recipients
- summer youth employees living in empowerment zones
The IRS requires records and verification when eligible employees are hired, and you need to be aware of data privacy issues. So you’ll need to work with your HR team to get the right systems in place in order to be eligible for and claim these credits.
Health Care Tax Credit:(Form 8941) A business with fewer than 25 employees that buys health insurance premiums via the Marketplace under a qualifying arrangement can claim at least 35% of the premiums paid. Eligibility criteria include that the business:
- pays an average annual wage for full-time employees of less than $56,000
- has fewer than 25 full-time employees
- purchased insurance premiums under a qualifying arrangement
- claims this credit for no more than two years in a row
Disabled Access Credit:(Form 8826) This tax credit is aimed at encouraging small businesses to make their premises more accessible for disabled employees and customers. Activities that this tax credit supports include:
- building and installing ramps
- providing wheelchair-friendly restrooms
- providing Braille text
Businesses are eligible for this credit if revenue is $1 million or less, or they have 30 or fewer employees. With this credit you can claim 50% of your disabled access expenditure, from $250 to $10,250. The first $250 cannot be claimed.
Renewable Energy Tax Credit: The US government provides a variety of tax credits for renewable energy, to reduce US dependence on oil. The amount that you can claim depends on which tax credit you apply for. The most common tax credit available for small businesses when it comes to renewable energy is the Qualified Electric Vehicle Credit (Form 8834).
Empowerment Zone Tax Credit:(Form 8844) The US Department of Housing and Urban Development has created empowerment zones to help stimulate the economy in low-income areas. The zones will last until 2025. Small businesses that qualify, can claim up to $3,000 for each full-time or part-time employee who lives in an empowerment zone. A list of empowerment zone locations can be found on the IRS website.
Small business deductions
Small businesses often overlook deductions that are available to them.
What are business deductions?
Business deductions are items and expenditures you can deduct from your business taxable income to reduce the amount of tax that you owe. It is a good idea to consult with a tax professional to ensure that you claim all the deductions that are available for your business.
Types of small business tax deductions available
When filing taxes, small businesses can claim a variety of deductions, including:
- qualified business income (QBI) deductions
- business phone bills
- car expenses or mileage
- office supplies
- office expenses such as rent and utilities
- health insurance premiums
- business-related travel expenses such as flights, train travel and car rental
- continuing education courses
- small office equipment, for example, printers and scanners
- business travel and related costs
- gifts to clients ($25 limit per person)
- retirement plan deductions
- depreciation deductions
There are other deductions you may be eligible for, which are on Schedule C on your tax return. They include the home office deduction and vehicle expense deduction. Please refer to this article on Schedule C tax deductions to learn more.
Business expenses may not be tax-deductible
Meals and entertainment are two common business expenses that are frequently not fully tax-deductible. There are specific criteria involving when meals can be deducted, and the deduction is limited even when they are deductible. Most entertainment is non-deductible. Find out more about the rules about deducting the cost of meals at the IRS website.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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