There are numerous tax deductions and credits that can help small business owners reduce their tax liability. Although deductions can help lower taxable income and potentially put businesses into a lower tax bracket, tax credits will actually reduce their tax bill on a dollar-for-dollar basis. Here are just a few small business tax credits every entrepreneur should know.
1. General Business Tax Credit
The General Business Tax Credit is a catchall tax credit designed to encourage business owners to invest in initiatives that help them retain employees, expand into new markets, or even make certain purchases, such as buying electric vehicles (EVs).
Eligible businesses include corporations whose stock is not publicly traded, partnerships, and sole proprietorships that meet the following requirement:
- Average annual gross receipts for the three tax years preceding the tax year the credit is taken does not exceed $50 million.
Several of the credits included on IRS Form 3800, General Business Credit, will be discussed in further detail below. Each credit, however, requires a separate form and is then included on Form 3800. Businesses that claim more than one credit are required to submit Form 3800 with their tax return.
2. Small Employer Health Insurance Premiums Credit
One way small businesses can offset their tax liability (regular and alternative minimum tax) is with the Credit for Small Employer Health Insurance Premiums (Form 8941). The credit is worth up to 50% of the premiums paid by the business owner for health insurance coverage if they meet the following three requirements:
- Paid premiums for employee health insurance coverage under a qualifying arrangement;
- Had fewer than 25 full-time employees for the tax year; and
- Paid average annual wages for the tax year of less than $58,000 per full-time employee.
For tax-exempt small employers, the maximum credit is 35% of premiums paid. It is taken as a refundable tax credit on Form 990-T, Exempt Organization Business Income Tax Return. The credit is also limited to the amount of certain payroll taxes paid.
3. Employee Retention Credit
Included in the CARES Act, the Employee Retention Credit incentivized companies to keep employees on the payroll if they had to close their business partially or fully during COVID-19. The refundable tax credit is worth 50% of the wages paid to staff in 2020 and 70% of wages paid in 2021. Qualifying wages are capped at $10,000 per employee in 2020, or $5,000 credit per employee. For 2021, it’s $10,000 in qualifying wages per employee per quarter or a maximum credit of $21,000 per employee. Recovery startup businesses are capped at $50,000 in credit per calendar quarter.
Companies that are eligible but didn’t take the credit on their 2020 return have until April 24, 2024, to file for it (Form 941). For the 2021 credit, business owners must file by April 15, 2025.
4. Work Opportunity Credit
Another credit included on the General Business Credit form is the Work Opportunity Credit (Form 5884). This tax credit is available to business owners who hire workers from certain targeted groups, including:
- IV-A recipients
- Designated community residents (DCR)
- Vocational rehabilitation referrals
- Summer youth employees
- SNAP benefits recipients
- SSI recipients
- Long-Term family assistance recipients
- Long-Term unemployment recipients
Employers must pre-screen and obtain certification that the employee is a qualified member of the targeted group before claiming the credit. In general, the Work Opportunity Credit is equal to 40% of up to $6,000 of wages paid to certified employees who are in their first year of employment and perform at least 400 hours of service. For qualified employees who perform at least 120 hours of service but fewer than 400, the credit is reduced to 25 percent. Additionally, up to $24,000 in wages may be calculated into the credit amount for certain qualified veterans.
5. Disabled Access Credit
Small business owners may be eligible for the Disabled Access Credit (Form 8826) if they make their facilities fully accessible to those with disabilities. This includes upgrading bathrooms, installing ramps or motion-activated doors, as well as other accessibility improvements. The credit covers up to 50% of the cost for expenditures between $250 and $10,250. The first $250 of expenses is excluded, however, so the maximum credit is $5,000.
To claim the credit, businesses must have a total revenue of $1 million or less, or have no more than 30 full-time employees.
6. Credit For Paid Family And Medical Leave
Internal Revenue Code Section 45S provides a tax credit for small business owners who provide paid family and medical leave to their employees. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 extends this credit through 2025.
To qualify for the credit, the company must have a written policy in place that meets certain requirements, including:
- A minimum of two weeks of paid family and medical leave annually to all qualifying full-time employees; and
- The paid leave is at least 50% of the wages normally paid to the employee.
If the company employs one or more qualifying employees not covered by title I of the Family Medical Leave Act (FMLA), the policy must also include “non-interference” language.
Qualifying employees include those who have been employed by the company for one year or longer. Additionally, the employee’s compensation for the preceding year must not exceed a certain amount.
The credit ranges between 12.5% and 25% and is equal to the applicable percentage of the amount of wages paid to a qualifying employee while the employee is on family and medical leave (up to 12 weeks). To claim the credit, business owners must complete Form 8894.
7. Credit For Employer-Provided Childcare Facilities and Services
Business owners who provide child care for their employees or assist with paying child care fees may be eligible to take this tax credit. The Employer-Provided Child Care Facilities and Services Credit (Form 8882) allows businesses of any size or type to claim 25% of qualifying expenses if the business:
- Builds or acquires, and then operates an in-house child care center; and/or
- Pays fees to a contracted licensed child care program (including home-based providers).
Additionally, business owners can claim 10% for costs associated with contracting a third-party referral service. The maximum annual credit is $150,000.
8. Small Employer Pension Plan Startup Costs Credit
Eligible employers may be able to claim a tax credit of up to $5,000, for three years, for the ordinary and necessary costs of starting pension plans for their employees. To qualify for the Credit for Small Employer Pension Plan Startup Costs (Form 8881), small business owners must:
- Have 100 or fewer employees who receive at least $5,000 in compensation for the preceding year;
- Have at least one plan participant who was a non-highly compensated employee; and
- In the previous three tax years prior to being eligible for the credit, have employees who weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by the company, a member of a controlled group that includes the company, or a predecessor of either.
Businesses, however, cannot deduct startup costs and claim a tax credit for the same expenses.
Not Really Tax Credits, But Great Ways to Save Money!
Although the following don’t qualify as tax credits, small business owners should be aware of them because they can potentially save them money.
9. Section 280A
Section 208A of the U.S. Code allows homeowners to rent out their homes for up to two weeks (14 days) without having to report the rental income on their individual income tax returns. This means that small business owners could potentially rent out their personal homes for business purposes, such as a company retreat or holiday party, and enjoy double tax savings. The cost of the employee event and property rental is a business deduction. The income derived from the rental is tax-free and isn’t included on the business owner’s personal tax return.
10. Section 179 Deduction
Section 179 is a tax deduction that allows small business owners to deduct the entire purchase cost of eligible equipment and software bought during the tax year. Examples of qualifying purchases include, but are not limited to:
- Manufacturing equipment and machines
- Computers and software
- Office furniture
- Personal property used for business purposes
- Security systems
- HVAC systems
Unlike the standard depreciation deduction, which takes smaller portions over several years, Section 179 allows the full amount in a single year. A business owner cannot deduct more than the total annual taxable income earned by the company. If the deduction exceeds the company’s net income, the overage may be carried forward to future years.
There are also limits on the total cost allowed and caps on how much a company can spend on property in a single calendar year. These amounts are adjusted annually for inflation. For the 2023 tax year, companies can deduct up to $1.16 million in eligible costs but may not spend more than $2.7 million on property. The Section 179 deduction will be reduced by any amount spent over the cap.
Claiming Section 179 requires good record-keeping and some math. To ensure you are taking the correct amount and not missing other small business tax credits or deductions, we recommend working with a tax professional. For a free quote, call Tax Defense Network at 855-476-6920. We offer affordable business tax preparation and other tax services