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Next Read: Business Tax Return Forms: Uses and Due Dates
Most entrepreneurs look forward to tax preparation season with the same amount of enthusiasm that kids usually have for a trip to the dentist. (Not that you can blame either party. Dentists are so widely dreaded that there’s a term for it: dentophobia.) Likewise, taxes can seem like a curse to business owners, adding pressure to the already slim margins of a small business.
Taking this comparison a step further, which is worse? Is the impact of taxes on the bottom line as painful as a root canal? While the answer to these questions is debatable, research shows that the average effective tax rate hovers around 20%.
“Small businesses of all types pay an estimated average effective tax rate of 19.8%,” says tax expert Jean Murray. “The effective tax rate is the average rate of tax for a business or an individual taxpayer. The effective tax rate is calculated by dividing the total tax paid by the taxable income.”
The good news is that the federal government offers dozens of tax credits to small business owners. These incentives are intended to reward businesses that take actions that align with objectives outlined by the IRS, throughout the year. Think of it as an “I’ll scratch your back if you scratch the economy’s back” arrangement.
It’s important to note that these tax credits differ from tax deductions in terms of how and when they’re applied. A deduction is tied to specific expenses, such as supplies and travel, related to your business. Every relevant deduction reduces your taxable income so you will owe less.
Tax credits, on the other hand, are applied after you’ve calculated your taxes. This distinction means any credit you qualify for will reduce the final amount you owe. While deductions impact your taxable income in smaller percentages, credits are dollar-for-dollar. A $1,000 credit will take exactly $1,000 off your tax bill.
Obtaining tax credits requires a proactive approach. It’s not like an IRS agent is going to tap you on the shoulder while you’re filing your taxes and say, “Wait! Let me show you a couple of quick ways to save thousands of dollars.” For this reason, it behooves you to educate yourself on possible tax credits way before tax season and structure your budget and spending accordingly throughout the year.
If your business is eligible for a tax credit, you can claim one by gathering the correct paperwork and filing Form 3800 with your tax return. The form will outline all available tax credits and you can determine which ones you’re eligible for and would like to claim before calculating your General Business Tax Credit.
Awareness is key. With that in mind, you should know about these 27 small business tax credits. Even if you qualify for just one or two of them, these credits could save you crucial money at tax time, leaving you with more cash on hand to run your business. (To see if you qualify, click the links below to view the individual form page on IRS.gov, where you can get additional details and submission instructions.)
Sometimes, it pays to do good. The Work Opportunity Tax Credit (WOTC) is available if your company hires people who traditionally face barriers to employment.
The IRS has defined 10 categories of WOTC-eligible workers:
Your WOTC amount is determined by the wages you pay qualified employees, but you could save up to $9,000 over two years.
The government wants individuals to plan for retirement, and that’s why they’re willing to help your business start a retirement program.
The Retirement Plan Startup Costs Tax Credit can help you recoup 50% of the “ordinary and necessary eligible startup costs” (up to a maximum of $500 per year) of starting a company-sponsored retirement plan. These ordinary and necessary costs include setup and administration fees, plus any money used to educate employees about the program.
This credit can be claimed only if you have 100 or fewer employees who received more than $5,000 in compensation from your business—and it’s only available for the first three years of your plan.
Fifty-five percent of full-time employees say health insurance is the most significant benefit they receive. However, health insurance can be complicated and expensive for small businesses.
The Credit for Small Employer Health Insurance Premiums seeks to alleviate some of that pain with a tax credit that will cover up to 50% of the amount you paid toward premiums for two consecutive years. To qualify, you’ll need to:
If you’ve invested money to make your business more accessible, then you likely qualify for a Disabled Access Credit. The IRS gives a broad list of eligible access expenses, but here are a few practical examples:
The Disabled Access Credit covers 50% of your expenses with a maximum credit of $5,000.
Businesses who provided paid family and medical leave for employees can qualify for a Family and Medical Leave Credit. This credit can cover 12.5% to 25% of what you paid your employees (which must be at least 50% of the regular pre-leave wages) for up to 12 weeks.
The Employee Retention Credit (ERC) is a refundable tax credit for employers who paid employees while experiencing a shutdown during the COVID-19 pandemic. While the credit applies only to 2020 and 2021 payrolls, if you have yet to claim this credit for the associated wages paid, you can still do so retroactively this tax season.
To be eligible for the ERC, your business must have been fully or partially shut down during the COVID-19 pandemic, qualified as a recovery startup business, or experienced a decline in gross receipts during that time. If you meet the requirements and have not yet claimed the ERC in previous tax years, you can claim up to a $5,000 credit per employee for 2020 and up to a $21,000 credit per employee for 2021.
The Credit for Increasing Research Activities (R&D Tax Credit) exists to incentivize business owners to increase their research and development in their sector and help generate more jobs to help boost the economy.
According to the IRS, examples of qualifying “research” include activities that discover technological information, relate to science, are useful in the development of new and improved business components, and constitute a process of experimentation. This also includes wages paid to employees who partake in such research and supplies put toward the investment.
This federal credit allows businesses to claim 20% of their research and development expenses for the year. However, the average annual gross receipts for a three-year period must be under $50 million.
The government offers many more business tax credits to encourage innovation and positive employment practices, as seen below.
Innovation
Employee Benefits
Community Development
Environment
Whether you’re seeking credits and deductions or just want to survive tax season without an emotional breakdown, remember to set aside enough time to make it all possible. Due diligence before and during tax season will allow you to consider all your options thoughtfully and confidently pursue those that are best for your business. Time is money for entrepreneurs, but the ROI on that time is excellent whenever you score a new tax credit.
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Lendio may receive compensation from H&R Block for referring you to their services.
Jesse Sumrak is a Social Media Manager for SendGrid, a leading digital communication platform. He's created and managed content for startups, growth-stage companies, and publicly-traded businesses. Jesse has spent almost a decade writing about small business and entrepreneurship topics, having built and sold his own post-apocalyptic fitness bootstrapped startup. When he's not dabbling in digital marketing, you'll find him ultrarunning in the Rocky Mountains of Colorado. Jesse studied Public Relations at Brigham Young University.
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