The run up to tax season can be a stressful time for new business owners. Just tracking down your expenses for the year can leave you needing a lie down in a dark room. And navigating the labyrinth of tax credits that your business might qualify for can feel overwhelming—if you’re even aware that these opportunities exist.
Identifying and claiming the business tax credits you qualify for is key to setting up your new business for success. Millions of dollars get left on the table every year in unclaimed tax credits—money that you can reinvest back into your business.
In this article we’ll give you the rundown on what tax credits are, exactly, and a quick guide on which tax credits you can apply for.
Business Tax Credits Defined
When you’re already swamped with a million and one things, going out of your way to learn about business tax credits might end up at the bottom of your never ending to-do list.
But when you understand what tax credits are, and how they can dramatically improve your bottom line, you’ll soon realize it’s worth investing some time to find all the tax credits your business qualifies for.
Put simply, tax credits are money that your business can subtract from your government taxes.
Here’s how they work. The government wants to offer certain business incentives to “reward” businesses for undertaking desirable corporate behavior. This can include things like undertaking research and development or setting up benefit plans for employees. There are many different categories of tax credits, all of which incentivize businesses by reducing tax bills.
Business tax credits are a dollar for dollar reduction on your tax bill. This is in contrast to tax deductions (which sometimes get confused with tax credits) which reduce your taxable income. Tax deductions lower the amount of money you’re paying tax on, and can move you into a lower income bracket, reducing your tax rate. According to NerdWallet, if you fall into a 12% tax bracket, $1 of deductions will save you $0.12 on your taxes, while in a 24% tax bracket a $1 deduction will save you $0.24. Tax deductions therefore have more impact the more income you’ve made, and are relatively modest.
Tax credits, however, directly reduce your tax bill, dollar for dollar. If you owe $25,000, a tax credit of $5,000 will reduce your tax owed to $20,000. This can be hugely beneficial, especially for small or new businesses.
5 New Business Tax Credits to Know
Once you know that it literally pays to apply for business tax credits, the next step is to find the tax credits you qualify for.
While every new business will be different, in this section we’ll share some of the best new business tax credits for you to focus on.
Small-Business Health Insurance Premiums (8941)
1. Small-Business Health Insurance Premiums (8941)
Want to provide health insurance to your employees? This tax credit will reward you for doing so. This tax credit applies to you if:
- You paid premiums for employee health insurance coverage. Your coverage must be part of a qualifying arrangement (defined by the IRS)
- You had fewer than 25 full-time equivalent employees (FTEs) for the tax year.
- You paid average annual wages for the tax year of less than $56,000 per FTE. Note, this is the 2020 figure and the exact amount will change each year. Make sure to check the figure next year.
The credit gives you back a maximum of up to 50% of the premiums you paid for employee health insurance. For tax-exempt eligible employers (this includes charitable and religious organizations, for example) the maximum amount is up to 35% of the premiums paid.
Learn more about the Small Business Health Insurance Premiums Tax Credit, read the instructions, and apply using form 8941.
2. Employer Credit for Paid Family and Medical Leave (8994)
This credit applies to employers who have a written paid Family and Medical Leave policy. In order to qualify, your policy must provide:
- At least two weeks of paid annual family and medical leave to all qualifying full-time employees (pro-rated for part-time employees)
- Paid leave not less than 50% of the employees usual wages
According to the IRS, paid Family and Medical leave can be used for instances such as the birth or adoption of a child, to care for a seriously ill spouse, child or parent, or if the employee themself has a serious health problem, among others.
Employers who claim the credit receive back a percentage of the wages they paid while an employee was on family or medical leave (up to 12 weeks per year). The tax credit ranges from 12.5% to 25% of the amount paid by the employer. Employers who pay more above 50% of the employee’s normal wages qualify for a higher percentage.
3. Small Employer Pension Plan Startup Costs Credit (8881)
If you set up a pension plan for your employees, you may be able to claim a tax credit of up to $5,000 for the first three years of the plan.
To be eligible for this tax credit, you need to:
- Have 100 or fewer employees who received at least $5,000 in compensation
- Have at least one plan participant who was a non-highly compensated employee (as defined by the IRS)
- Not have had employees who received benefits in another plan that you sponsored in the three years before you first qualify for the credit.
The credit is intended to cover costs such as setting up and administering the plan, as well as educating employees about the plan.
4. Work Opportunity Tax Credits (5884)
The Work Opportunity Credit exists to encourage employers to hire people from groups who suffer significant barriers in employment. This includes groups such as veterans, ex-felons, SNAP recipients, and more.
The Work Opportunity Credit generally provides 40% of up to $6,000 of the wages paid to an eligible employee when they are in their first year of employment and have worked for you for at least 400 hours. In order to claim the credit, you will need to certify that any employees meet the criteria in advance.
5. Increasing Research Activities Credit (6765)
Businesses often count themselves out of Research and Development tax credits, wrongly believing that they are only applicable to science, technology, and medical companies. However, many new businesses do perform their own R&D and may be eligible for this tax credit.
The activities the IRS states qualify for this credit can include:
- Developing a new prototype or model
- Developing and applying for a patent
- Developing a new manufacturing or business process
- Streamlining business processes
- Building or improving manufacturing facilities
- Environmental testing
The criteria is relatively broad, and it can be challenging to identify if your R&D qualifies. If you’re not certain, it may be worth consulting a tax professional. If you are eligible, the credit covers up to 20% of expenses.
Get Your New Business Set with Tax Credits
Learning to love your admin tasks is a key challenge for many new business owners. But if you can get on top of your tax admin and make the time to apply for more new business tax credits, you could save your company thousands of dollars and set yourself up for long term success.
Learn more about how Charli makes staying organized at tax season (and all year!) easy for you and your team.