6 Tax Credits to Reduce Your Business Taxes
Including 2020 Tax Credits for Coronavirus-Related Reasons
For most business owners, the term "tax credit" signifies something good, but they are not sure what the term means, and tax credits are often confused with tax deductions. As you will see, tax credits are better than deductions. Also explained in this article are some of the most common tax credits that businesses can use to lower taxes.
Tax Credits vs. Tax Deductions
Tax credits are given to businesses and individuals as incentives for certain kinds of activities. For example, businesses can get tax credits for purchasing energy-efficient vehicles and building with "green" products. Usually, a tax credit is offered for a specific time period, ending after that time has ended. In the cases below, these actions benefit the economy, the environment, business development, or other positive business purposes.
Tax credits are superior, in terms of tax savings, to deductions. Tax credits are deducted from income before gross before-tax income is determined. Tax deductions are taken in the next step of the tax process, reducing the net taxable income.
Tax Credits for Purchases
For tax credits for business purchases, you must have purchased and put into service (started using) the equipment, vehicle, or facility in the year when you claim the tax credit.
Two New Coronavirus Tax Credits
In response to the coronavirus emergency, several new tax credits are available to businesses:
- An employee retention credit to give businesses an incentive to keep employees working, and
- Tax credits to help employers pay for sick leave and family leave for employees affected by COVID-19,
You can take these tax credits quickly by deferring payment of your employer part of Social Security taxes withheld from employees on Form 941, the quarterly payroll tax report. See this article with FAQs on deferring tax credits in 2020 for more information.
Employee Retention Tax Credit
As part of the 2020 CARES Act, the IRS created an employee retention tax credit to incentivize employers to keep paying employees. Your business can get a fully refundable tax credit with up to 50% of qualified employee wages up to $10,000 you pay employees after March 12, 2020. The maximum amount of tax credit for each employee is $5,000.
A recent update to the CARES Act included these changes to the employee retention tax credit, including:
- Extension of the tax credit through June 30, 2021
- Expanded eligibility by reducing gross receipts decline from 50% to 20%
- Increased the limit on per-employee creditable wages from $10,000 for hte year to $10,000 per quarter
- Increased the employee base from 100 to 500 or fewer employees
- Provides that employers who receive Paycheck Ptotection Program (PPP) loans may still qualify for this tax credit, but not for wages paid for with forgiven PPP proceeds.
- Clarified that group help plan expenses can be considered qualified wages in some circumstances
Your business can continue to be eligible for the credit while you continue to give health insurance benefits to employees who have been laid off.
Tax Credits for Paying Employees on Sick Leave and Family Leave
The 2020 Families First Coronavirus Response Act (FFCRA) helps employers provide sick leave and family leave to employees.
Paid Sick Time. Small and mid-size employers (those with fewer than 500 employees) must give up to 80 hours of paid sick time to employees for coronavirus-related issues for staying home for their own illness or someone who needs care.
Paid Family Leave. In addition, employers must give employees paid family leave to care for a child who needs care. This requirement is a part of the Family and Medical Leave Act, which requires larger employers to give unpaid leave to employees.
Employers who have these expenses can get tax credits for part of the cost of providing these payments to employees. They can take the tax credits by deferring the employer's part of Social Security benefits on the employees' wages, through December 31, 2020.
The program originally ended December 31, 2020, but Congress has extended the credits through March 31, 2021, for qualified leave wages. You can also pay employees for qualified leaves, as long as the wages are for leaves that employees took between April 1, 2020, and March 31, 2021.
The Affordable Care Act (Obamacare) includes a small employer health insurance tax credit to encourage small employers to offer health insurance for the first time or maintain coverage they already have.
The credit is available to small businesses that pay at least half the cost of single coverage for their employees. If your business and your plan meet the qualifications, you can get a credit of up to 50% of the health insurance premiums you paid for employees, but not for yourself as the business owner.
To be eligible for the credit, you must:
- Have fewer than 25 full-time equivalent employees,
- Average wages must be less than $54,200 for the tax year, and
- Pay for these premiums using an IRS-qualified arrangement
Self-Employment Health Insurance Deduction
If you are self-employed, you can get a similar tax deduction for yourself, your spouse, and your dependents. This self-employed health insurance deduction is available for the costs of medical insurance, dental insurance, and long-term care policies. You can deduct these costs up to the total of your self-employment income.
Research and Development tax credits have been available for many years, but small businesses often don't realize they can qualify for these credits. This credit is specifically for increasing research activities, and you don't have to be a large company to get the credit. A sole proprietor, partnership, or non-public corporation is eligible.
Even if your business doesn't do traditional scientific research, you may be eligible for this tax credit for other kinds of research, including:
- Product development,
- Surveys or studies,
- Improving product quality, reliability, or function,
- Improving business performance, and
- Payments to outside researchers or employees who do research.
Qualified research activities must be able to show a connection between the expenses claimed and the research activity.
The credit is for up to 20% of qualified research expenses, up to $250,000 annually.
If you make changes to your business location to accommodate employees and customers with disabilities, you may be eligible for disabled access tax credits.
To qualify for this credit, your business must earn $1 million or less and have no more than 30 full-time employees the previous year.
Your business may also be able to take a tax deduction for removing architectural and transportation barriers for employees and others. You can get this deduction in addition to the tax credit described above.
Making changes to your business with equipment to make it more energy efficient or more environmentally "friendly" can benefit you through tax credits. In addition to the tax credits, you may also be eligible for tax deductions for changes made to your business facilities.
For example, the Business Energy Tax Investment Credit gives businesses credit for purchasing or implementing energy-saving activities, like fuel cells, wind, and solar energy.
To qualify your business must own or have built the equipment and it must meet specific quality and performance standards.
Tax Credits for New All-Electric and Plug-in Hybrid Vehicles
If you buy a new all-electric car or a plug-in hybrid vehicle you may be eligible for a federal income tax credit of up to $7,500. The amount of the credit varies depending on the battery used to power the vehicle. You can't use the credit for a used vehicle for your business.
The credit is for vehicles bought after December 31, 2009, and it starts phasing out when at least 200,000 qualifying vehicles have been sold. To claim the credit, use IRS Form 8936 Qualified Plug-In Electric Drive Motor Vehicle Credit.
The Work Opportunity Tax Credit allows employers to get a business tax credit for hiring new employees in certain categories:
- TANF Recipients (Long-Term Temporary Assistance for Needy Families)
- SNAP (Food Stamp) Recipients
- Designated Community Residents (living in Empowerment Zones or Rural Renewal Counties). Empowerment Zones are defined areas
- Vocational Rehabilitation Referral
- Supplemental Security Income Recipients
- Summer Youth Employee (living in Empowerment Zones)
The credit is taken against the employer's share of the employees' Social Security tax (6.2% of wages).
Before You Apply, Discuss with Your Tax Professional
All tax credits come with restrictions and qualifications that you must meet. You can't apply for a tax credit until you have spent money on the purchase or the activity, so get help from your tax professional before you make this commitment.