Tax credits offer small businesses a powerful tool to reduce their tax liability. Stay on top of all tax credits for small businesses. Business activities change—tax credits change. At least once every quarter, commit to 20 minutes of research. What you’re looking for is alignment between business activities and tax credits that could qualify you for new tax credits.
Here’s my perspective as an experienced CPA: Rather than viewing tax credits as a potential “bonus” during tax season, small business owners should think of them as a vital part of their long-term financial outlook and plan accordingly, year-round.
Tax credits are also, unfortunately, complicated. Small business owners already have a lot on their plate. Unless you’re a tax professional, like a Certified Public Accountant (CPA), it can be difficult to know which ones you qualify for. This guide offers an introduction to tax credits for small businesses to help you get a handle on the subject.
We’ll take a look at
- What tax credits are;
- How to use them to strengthen your business;
- Which tax credits to pay particular attention to; and
- New credits will apply now.
Stay on top of the tax code changes every year
The federal tax code changes every year. If you’re operating on knowledge from last year’s tax season, you’re already out of date. That’s why small business owners need to be aware of changes in tax laws. Tax code modifications will have a significant impact on your finances this year.
New opportunities for 2023
In addition to maximizing your return when filling out your taxes, you can help your small business grow by changing your behavior to take advantage of new tax credits.
For example, it could make sense for your business to invest in
- An electric vehicle;
- Real estate in low-income areas; and
- Health insurance for your employees.
Tax credits reward business activities that align with government initiatives
What is the purpose of a tax credit? It’s not charity. It’s not about Reagan’s “a rising tide lifts all boats.”
So, what does a tax credit do? Why do tax credits exist in the first place? It’s important to know the why before you dive into the how.
Business owners need to know the underlying purpose of tax credits to maximize savings
No matter how detailed and specific the process, you will make better decisions if you understand and return often to the core principle behind the process. Memorize this:
Tax credits are a means for the government to further its interests by encouraging or discouraging certain activities in the private sector. “Encourage” means direct incentives for business behavior that propels government priorities and supports legislative and bureaucratic initiatives.
Give equal consideration to business benefits and government intent
On the business side, we default to benefits and outcomes.
Tax credits provide tax savings that lower the overall cost of doing business. The result is an increase in gross income independent of sales and revenue. This is all true.
But the government doesn’t create new tax laws, alter the tax code, or come up with new regulations for charitable purposes.
Here’s the process:
- See the potential to qualify for a tax credit
- Learn the government’s intent and objectives
- Compare costs to tax savings
Or, you can give me a call, send over your books, and I’ll find every single tax credit you qualify for, even if it’s a stretch. Because my job is to use the tax code to its fullest extent available under the law.
A win for the government, for businesses, and for citizens
The government grants tax credits for business activities like research and development (R&D), employee benefits, and investment in low-income communities. In doing so, they seek to incentivize individuals and companies for actions that improve the economy, combat climate change, provide employment, and enhance others’ lives.
A tax credit is not the same as a deduction
Tax credits are just one of several methods the government uses to incentivize financial behavior. Tax deductions are, on the face of it, similar: Both reduce your tax bill, but in different ways.
Tax credits directly reduce your business’s tax liability.
Tax deductions lower your taxable income.
It’s crucial for small businesses to pursue both tax credits and deductions. However, the benefit from tax credits is more direct—they’re a dollar-for-dollar reduction from your tax bill.
Refundable vs. non-refundable tax credits for small businesses
There are two kinds of tax credits: non-refundable and refundable.
Non-refundable tax credits reduce a taxpayer’s tax liability, but they can’t lead to a refund. That means if your non-refundable credit is larger than your tax bill, you’re left with an unused portion of the credit.
Non-Refundable tax credits include
- Residential energy efficient property credit
- General business credit
- Alternative motor vehicle credit
A refundable tax credit, on the other hand, can be refunded. So if you take advantage of a refundable credit, and it’s greater than your bill, you’ll receive the difference.
Most tax credits for small businesses are non-refundable, but there are exceptions — the Employee Retention Tax Credit (ERTC), for one. Keep in mind, the ERTC only applies to wages distributed between March 13, 2020, and December 31, 2021. However, you can still send in applications to receive the ERTC for those wages.
Small businesses often miss tax credits
Many small businesses, whether they’re overwhelmed with other responsibilities or are not aware of their financial options, overlook potential tax credits.
The result of missed tax credits is unused funds — free money turned down.
In some cases, you can amend your return filed in previous years to receive tax credits you missed. (I am writing a comprehensive article on amending tax returns, and I’ll link that article here when it’s published). If that’s not possible, use this as a reminder to stay informed about tax credits for small businesses regularly.
How to claim a small business tax credit
I have to give credit to the Internal Revenue Service (IRS). It’s easier for non-professionals to get accurate information. Start by visiting the IRS web page on Business Tax Credits.
You’ll find links to all the forms you need to claim tax credits.
In addition to the specific form for the tax credit you’re seeking, you may also need to file Form 3800,1 for General Business Credits, available here.
Reminder: You Still Need a CPA
Access to forms, guidelines, and instructions is a great thing, and my articles are meant to help business owners expand their tax and accounting literacy and stay abreast of opportunities.
What should you, the business owner, do with the information I provide? My intention is that you use it to grow and deepen your relationship with your CPA. There needs to be collaboration, and you need to speak up and ask questions.
What I cannot recommend is a D.I.Y. attitude toward complex tax issues. You’re making at least $500,000 in revenue. Stay informed and hire a professional.
Tax credits to look for
The following is a list of tax credits that I want to make you aware of. This isn’t an exhaustive list, but it’s a good place to start.
Research and development (R&D) tax credits reward you for improving products
We’ll begin with a big one. The Credit for Increasing Research Activities, more commonly known as the Research and Development (R&D) tax credit, encourages businesses to invest in innovation and new technology.
This category can cover a range of expenses, including
- Environmental or certification testing;
- Development of products, models, or patents
- Building or improving facilities
Only 30% of qualifying businesses claim R&D credits
According to CO, a website from the U.S. Chamber of Commerce, fewer than 3 in 10 (or 30%) qualifying small businesses claim an R&D tax credit.2 You don’t want to be one of those businesses leaving money on the table.
How to join the 30% club
Many business owners assume the R&D tax credit is limited to scientific research, but that’s not the case. If you’ve worked to improve a product, there’s a good chance you’re eligible,
That’s more true now than ever. The Inflation Reduction Act of 2022 included a provision to increase the R&D Tax Credit from a maximum of $250,000 to $500,000.
You can claim R&D tax credits by using Form 6765.
The Employee Retention Tax Credit is no more, but you may still be able to qualify for previous years
The Employee Retention Tax Credit was created to help businesses keep their employees on payroll during COVID-19. This tax credit was available to eligible employers who have experienced a full or partial suspension of their operations or a significant decline in gross receipts.
As I said earlier, this credit applied only to wages paid through 2021, so you can’t claim it on your return this year. But there’s still time to take advantage.
You can amend your tax returns within three years after filing, meaning you can go back to your 2020 and 2021 returns to claim the ERTC. It was worth up to $7,000 per quarter per employee while in effect, so it’s definitely worth amending if possible.
The Work Opportunity Tax Credit offers money for hiring
The Work Opportunity Tax Credit (WOTC) helps employers offset the costs of hiring and training employees from certain targeted groups.
You can find the full list of qualifying targeted groups on the IRS website, but they include
- The formerly incarcerated or those previously convicted of a felony;
- Individuals experiencing long-term unemployment; and
- Individuals whose families are recipients of state assistance.
Before you can claim the credit, a qualifying individual must meet a few other requirements: They have to be in their first year of employment and work for your business for at least 400 hours.
The WOTC allows a business to claim 40% of up to $6,000 of wages paid, meaning a maximum of $2,400 per individual.
The Small Business Health Care Tax Credit makes offering health care affordable
Here’s one specifically for small businesses. The Small Business Health Care Tax Credit is designed to help offset the costs of providing health insurance for employees.
There are a few stipulations. To qualify, you must
- Have fewer than 25 full-time equivalent employees;
- Pay average annual wages of less than $51,000; and
- Contribute a significant portion of the premium cost.
This one’s worth up to 50% of the costs your business pays for your employees’ premiums. It’s also available for two consecutive years.
The New Markets Tax Credit is for investment in low-income communities
The New Markets Tax Credit (NMTC) encourages investment in businesses located in low-income and rural areas, helping to spur economic growth and create jobs. To qualify, you must invest in a Community Development Enterprise (CDE) or a Community Development Financial Institution (CDFI).
Projects must be in census tracts with either:
- Greater than 20% poverty rate, or
- Less than 80% of the area’s median income.
Some projects that qualify for the NMTC are community healthcare centers, grocery stores, and schools.
Start implementing 2023 tax credits now
Making the most of tax credits means year-round planning, not just filling out the proper forms when you fill out your taxes.
Stay informed about changes to tax credits that you’ll be able to make this year.
It’s a good time to set up a retirement plan
On December 29, 2022, the revised Setting Every Community Up for Retirement Enhancement Act (SECURE 2.0), was signed into law. This act is a revision of the 2019 SECURE Act, which sought to make it easier for Americans to save for retirement. It helps small businesses establish retirement plans for their employees.
Now, small businesses with 50 or fewer employees can receive a credit to cover all of their administrative costs, up to $5,000 for the first three years of plans. You’ll also be able to claim a credit of up to $1,000 in employer contributions to each employee’s plan.
Looking ahead to 2024, SECURE 2.0 will permit businesses that don’t offer retirement plans to offer a starter 401(k) plan or safe harbor 403(b) plan. Businesses that use a starter plan aren’t required to match contributions, so it’s affordable. It should offer a strong incentive for employers to establish retirement offerings for employees.3
Get a tax credit if you invest in electric vehicles
For the first few months of the year, you can claim a tax credit of up to $7,500 if you purchase an electric vehicle.
Expect to see many businesses investing in electric vehicles early in 2023,4 and consider if you should do the same. The credit won’t last, though, because of how the Inflation Reduction Act is being implemented—piecemeal, over time. That means it won’t be long until, for some vehicles, the credit will drop to $3,750.
The credit is even larger for “qualified commercial clean vehicles” and doesn’t come with those same time restrictions. Those larger than 14,000 pounds may allow you to claim up to $40,000. The clean commercial vehicle tax credit is good through the end of 2032.
Here’s a FAQ from the IRS about tax credits for qualifying vehicles.
Tax credits for small businesses are worth the effort
Yes, tax credits can be overwhelming, but the benefits are too large to ignore. If your business qualifies, it’s in your best interest to apply for every available tax credit.
You should also keep new tax credits in mind when you engage in strategic planning. Looking to the future, there are numerous opportunities — whether you’re looking to invest in innovation, provide a retirement option to help retain your employees, or make it more affordable to hire new ones — to benefit your business.
Let’s get those tax credits
Our firm works with small businesses between 500K and 10M dollars in annual revenue and offers an integrated, enterprise-level solution for tax, tax planning, accounting, and financial leadership.
We meet in person once a month, and every month we adjust our strategies to maximize tax efficiency and provide a financial perspective that improves decision-making at all levels.
Click here to schedule a discovery call with me and my tax team.
Talk soon,
Jeremy A. Johnson, CPA
References
- Business tax credits. Internal Revenue Service. Available from: https://www.irs.gov/businesses/small-businesses-self-employed/business-tax-credits
- Emily Heaslip. How to qualify for and claim the R&D tax credit. CO. The U.S. Chamber of Commerce. Available from: https://www.uschamber.com/co/run/finance/research-and-development-tax-credit
- Rhett Buttle. SECURE 2.0. Forbes. Available from: https://www.forbes.com/sites/rhettbuttle/2023/01/05/secure-20-5-things-small-business-owners-need-to-know/?sh=4436509a8bff
- Peter Valdes-Dapena. Tax credit confusion could create a rush for electric vehicles in early 2023. CNN. Available from: https://www.cnn.com/2022/12/28/business/ev-tax-credit/index.html