Discover 9 Overlooked Small Business Tax Credits: US Tax Made eZ

9 Overlooked Small Business Tax Credits

Key Points

  • Credits are dollar-for-dollar reductions of your tax liability, while tax deductions reduce your taxable income base.
  • Small business owners qualify for numerous tax credits to lower their taxable income.
  • Some tax credits often expire after a few years. Small business owners must act quickly to review eligibility criteria and take advantage of potential benefits.

Table of Contents

  1. Differentiating Between a Tax Credit and a Tax Deduction
  2. Tax Credits Overlooked by Small Business Owners
    • Work Opportunity Tax Credit
    • R&D Tax Credit
    • Retirement Plans Startup Costs Credit
    • Plug-In Electric Drive Vehicle Credit
    • New Markets Credit
    • Employee Retention Tax Credit
    • Empowerment Zone Employment Credit
    • Alternative Motor Vehicle Credit
    • Employer Social Security and Medicare Taxes Credit
  3. How to Claim Small-Business Tax Credits
  4. Conclusion

The IRS and numerous state agencies offer a variety of tax credits geared toward small business owners, yet many small businesses neglect to leverage these tax breaks fully.

In this article, we’ll cover 9 overlooked small business tax credits you can claim and save some serious money on your next tax return.

1. Differentiating Between a Tax Credit and a Tax Deduction

Before we get into overlooked tax credits, it’s important we differentiate between a tax credit and a tax deduction. A tax deduction reduces your taxable income, while a tax credit reduces your tax liability. Tax deductions work similarly to business expenses. This makes tax credits more beneficial to small business owners.


Case 1:

Facts:
  • Andre is a chef and owner of a bakery-style cafe offering French delicacies, Bonjour Café.
  • Bonjour Café brings in $500,000 in revenue.
  • Expenses are as follows:
    • Cost of Goods Sold: $100,000.
    • Operating: $200,000
    • General & Admin: $50,000
  • Tips received by employees: $75,000
  • Andre’s tax filing status: Married Filing Jointly
  • The couple has no dependent
  • W-2 from Bonjour Café: $60,000
  • Bonjour Café is the only source of income for the couple
  • Their itemized deductions: $40,000
Issue:

How can Andre utilize deductions and credits to pay less tax?

Calculation:
  • Bonjour Café’s Tax Return 1120S
    • Net Income: $150,000 [$500,000 – $100,000 – $200,000 – $50,000]
    • Qualified Business Income Deduction $30,000 [$150,000 x 20%]
    • Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips: $5,738 [$75,000 x 7.65%]
  • Andre’s Tax Return 1040
    • Adjusted Gross Income: $210,000 [$150,000 + $60,000]
    • Taxable Income: $140,000 [$210,000 – $30,000 – $40,000]
    • Tax Rate: 22%
    • Tax: $21,415
    • Total tax after credit $15,677 [$21,415 – $5,738]
Results:

Andre utilized several deductions to reduce his gross revenue of $750,000 to taxable income of $140,00 and then further reduced his tax due from $21,415 to $15,677 with the qualified credit.


Can you see the power of tax credits and deductions?

2. Tax Credits Overlooked by Small Business Owners

Now, let’s cover 9 commonly missed small business tax credits you might be able to take.

1: Work Opportunity Tax Credit

As a part of the Consolidated Appropriations Act of 2021, the Work Opportunity Tax Credit was extended through the end of 2025. This tax credit is applicable to employers who hire individuals in target groups, such as ex-felons, individuals on temporary assistance, SNAP recipients, and some veterans.

If you hire individuals from any of these groups, you might be eligible for a credit of up to $2,400 for each employee. There are some restrictions. For one, the employee must have worked at least 400 hours during the year. In addition, employers must apply for and receive a certification that verifies the new hire is an eligible employee.

2: R&D Tax Credit

The Research and Development Credit is available to employers who look to improve processes and products through research-based activities. Qualifying research expenditures include supplies and contract labor. This credit is claimed by filing Form 6765 on your tax return.

There are two main methods to claim the R&D credit: simplified and regular. The regular credit method produces the highest ratio of credits per dollar but requires more documentation and legal work to establish a fixed-base percentage. On the contrary, the alternative simplified credit produces a smaller credit but involves much less documentation.

It’s important to note that there were recent changes in how research and experimental expenditures were handled for tax purposes. The IRS now requires 90% of these expenses to be capitalized and amortized over a 5-year period. This means if you have $100,000 in R&D expenses, you are only allowed to deduct $10,000 in the first year, resulting in a $90,000 add back to taxable income.

This isn’t ideal from a tax planning standpoint, and lawmakers are still working to reverse this ruling. You are required to capitalize R&D expenditures regardless of whether you claim the credit. Claiming the credit can be a great way to offset some of your tax liability associated with the capitalization requirements.

3: Retirement Plans Startup Costs Credit

The IRS incentivizes employer-sponsored retirement plans by offering a startup credit called the Retirement Plans Startup Costs Credit. Employers that establish a SIMPLE IRA, 401(k), or SEP plan can claim a tax credit of up to $5,000 for the first three years of the plan on Form 8881.

Eligible employers are those that have 100 or fewer employees who receive at least $5,000 in compensation each and have at least one plan participant who is not highly compensated. In addition, you must not have had another benefit plan in place for the prior three tax years before you’re eligible for the credit.

This tax credit is based on eligible expenses, which include plan administrator setup costs and employee education. The credit calculation is based on 50% of eligible expenses, up to $500 or the lesser of $250 multiplied times your number of non-highly compensated employees or $5,000.

4: Plug-In Electric Drive Vehicle Credit

Are you thinking of purchasing a new business vehicle? If so, you might qualify for the Plug-In Electric Drive Vehicle Credit. This credit is available to businesses that purchase a 2023 or newer vehicle that has a plug-in electric component and is claimed on Form 8936. The gross vehicle weight must be under 14,000 pounds, have an external charging source, and be manufactured by a company that has sold 200,000 or fewer electric vehicles in the United States.

Additionally, vehicles must have undergone final assembly in North America. If you meet all of these requirements, you might be eligible for a tax credit of up to $7,500. This is a major credit if you are already planning on purchasing a vehicle in the upcoming few years. Dealerships should be able to tell you if your vehicle qualifies for this new tax credit. In addition, the U.S. Department of Energy has a great resource for determining what qualifies and calculating your tentative credit.

5: New Markets Credit

The New Markets Credit is a tax incentive that helps revitalize struggling industries by providing a 39% tax credit over a seven-year period to private investors who are tackling development projects in low-income communities. This credit is claimed on Form 8874.

A low-income community is one where the population poverty rate is at least 20% for census-tracked areas. Communities that are not census-tracked will have a median family income of less than 80% of the statewide median family income. If your business focuses on community development, this might be a great opportunity to claim a significant tax credit.

6: Employee Retention Tax Credit

The Employee Retention Tax Credit has been widely claimed over the past few years, with many employers getting thousands of dollars back. This is a payroll tax credit claimed on your quarterly 941. Employers who experienced a decline in gross receipts during the pandemic or were forced to close down due to government orders can claim this credit.

The 2021 credit limits are up to $7,000 per employee for the first three quarters. The deadline to claim this credit is approaching, meaning now might be the perfect time to look into if you qualify.

7: Empowerment Zone Employment Credit

The Empowerment Zone Employment Credit is designed to help individuals in distressed areas. This credit is equal to 20% of your qualified zone wages, up to $15,000. Qualifying zone wages are those paid to employees working in certain geographic locations. The IRS has a full list of which areas qualify. This credit is claimed on Form 8844.

The IRS doesn’t allow you to double-dip on certain credits. This means that your qualified zone wages will need to be reduced by the Work Opportunity Credit. Nevertheless, if you employ individuals in an empowerment zone, this can be a nice tax break to take advantage of.

8: Alternative Motor Vehicle Credit

The Alternative Motor Vehicle Credit gives way to a tax deduction for small businesses that purchase vehicles powered by alternative fuel sources. To qualify for this credit, you must be the owner of the vehicle, the original use of the vehicle began with you, you acquired the vehicle for use, and you primarily drive the vehicle in the United States. This credit is claimed on Form 8910.

Electric vehicles are the most common qualifying vehicle for this tax credit. The credit amount is determined by the manufacturer’s certification to the IRS. Most dealerships will be able to provide you with all the necessary information to claim this credit if you purchase a vehicle with an alternative fuel source.

9: Employer Social Security and Medicare Taxes Credit

The Employer Social Security and Medicare Tax Credit is available for employers with employees who receive tips. Employers that pay FICA taxes on the tips received by employees can claim a credit when they file their annual tax return by filing Form 8846. Furthermore, employers cannot claim credit on tips that bring the employee up to the Federal minimum wage.

Only tips in excess of minimum wage are eligible for this tax credit. Small businesses in the food and beverage industry can easily qualify for this tax break, allowing you to put more money back into your pocket for expenses already paid during the year.

3. How to Claim Small-Business Tax Credits

Step 1: Identify Eligibility: Check if your business qualifies for any small-business tax credits. Each credit has its own criteria, so make sure you meet the requirements.

Step 2: Complete Individual Tax Credit Forms: For each eligible tax credit, fill out the specific form associated with that credit. The forms are listed below. If you qualify for only one credit, you don’t need to submit Form 3800, which is the general Business Tax Credit.

Step 3: Calculate Total Tax Credits: On Form 3800, if applicable, add up the values from each individual tax credit form. This gives you the total value of your small-business tax credits.

Step 4: Check Limits: Determine if there’s a limit on the amount of tax credits you can claim. Use the following formula:

  • Add your net income tax and alternative minimum tax.
  • Subtract the greater of your tentative minimum tax or 25% of the amount of your regular tax liability in excess of $25,000.

Step 5: Include Forms with Your Tax Return: Submit the necessary forms along with your tax return.

Step 6: Consider Carryforward: If you’re unable to claim a tax credit in the current year, check if you can carry it forward to a future tax year. Keep in mind that when you claim a tax credit, you usually can’t also claim a deduction for the same expense.

4. Conclusion

By uncovering tax-saving opportunities like credits, small business owners are empowered to optimize their tax strategies and capitalize on available credits to boost their financial bottom line.


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