For many small business owners, navigating the ins and outs of taxes can seem insurmountable. Because of this, few business owners are aware of the full range of tax credits and deductions of which they can take advantage. For instance, less than three in 10 small businesses that qualify for the Research & Development (R&D) Tax Credit claim it, while most large companies make the claim.
To help you keep more of your hard-earned money on your tax return, here are some lesser-known tax credits and deductions you may be eligible for this year.
[Read more: Tax Season Planning You Should Be Doing Now]
What’s the difference between a tax credit and a tax deduction?
A tax deduction reduces how much of your business income is subject to taxes by potentially putting you into a lower tax bracket. A tax credit is more straightforward because it reduces the amount of tax owed by giving you a dollar-for-dollar reduction of your liability. For instance, a tax credit valued at $500 will lower your bill by $500.
Too often, business owners focus exclusively on deductions and ignore the potential to claim equally beneficial credits. Business owners can claim both credits and deductions as long as they meet the necessary qualifications.
Tax credits commonly missed by small businesses
The R&D tax credit is one for which many small business owners believe they are not eligible. However, there are many others, said Patrick Butler, CPA and Partner at Reynolds + Rowella. Here are a few credits that many business owners may be eligible to claim on this year’s tax return.
[Read more: How to Qualify for and Claim the R&D Tax Credit]
Work Opportunity Tax Credit
The Consolidated Appropriations Act in 2021 extended the Work Opportunity Tax Credit (WOTC) program until December 31, 2025. The WOTC can be claimed by employers who hire individuals facing barriers to employment, explained Butler. Those categories include qualified Temporary Assistance for Needy Families recipients, ex-felons hired before reaching one year past their conviction date or prison release, qualified SNAP recipients, and some veterans, among others.
In addition to the categories of workers hired, the WOTC is based on the wages paid to those employees in their first year of employment who have worked at least 400 hours. Small businesses can receive a credit for up to $2,400 for every new full-time hire meeting the specifications of this tax credit.
R&D tax credit
The R&D tax credit offers a tax liability reduction opportunity to businesses innovating a process or product. The tax credit is available to businesses of all sizes for qualifying research activities, including software development, architectural design, product enhancements, and more. Businesses can also be eligible for this tax credit for qualifying basic research payments, though this is less common.
Effective 2024, changes will be introduced to Form 6765 for the R&D tax credit (drafted changes can be accessed here). The changes are focused on disclosing data relating to associated wage expenses and business component details. These changes made by the IRS are aimed at preventing fraud and enhancing data accuracy for the credit.
SECURE 2.0 Act
Kevin Hamaker, CPA, MPAcc, CEO at The Hamaker CPA Group, explained that effective January 1, 2020, and later updated on December 29, 2022, the SECURE 2.0 Act offers credits for implementing a 401(k) plan or adding an auto-enrollment feature to a plan. SECURE 2.0 has various provisions, including increasing the RMD age for IRA and 401(k) accounts and altering the catch-up contribution limit for older workers with workplace plans. The legislation also aims to assist younger individuals with saving while repaying student loans, simplify transferring accounts from one employer to another, and allow people to save for emergencies using retirement accounts.
As of tax year 2023, the IRS implemented changes to the SECURE 2.0 Act that could affect the amount businesses need to report on their W-2 forms. These provisions may include:
- Roth Savings Incentive Match Plan for Employees (SIMPLE).
- Roth Simplified Employee Pension Individual Retirement Arrangements.
- De minimis financial incentives.
- Optional treatment of employer nonelective or matching contributions as Roth contributions.
Additional tax credits small businesses can take advantage of
Butler offered a few other suggestions for federal tax credits small businesses can explore, including:
- Retirement Plans Startup Costs Tax Credit: Eligible employers can qualify for this credit to cover the initial costs of establishing retirement plans like SIMPLE IRA, 401(k), or SEP. Meeting the specific eligibility requirements related to employee count, compensation, and plan history can reduce the amount of taxes owed by the business.
- Plug-In Electric Drive Vehicle Credit: If your business purchased a new plug-in electric vehicle in 2022 or earlier, this credit of up to $7,500 could be available to you. Qualifications include a gross vehicle weight under 14,000 pounds, an external charging source, and manufacture by a company that has sold fewer than 200,000 electric vehicles in the United States. Vehicles purchased after August 16, 2022, must undergo final assembly in North America to qualify.
- Alternative Motor Vehicle Credit: Individuals who qualify for this tax credit must be the original buyers of eligible vehicles powered by alternative energy sources for business or investment use. The tax credit is available to those who use the vehicle primarily in the United States.
- Empowerment Zone Employment Credit: With this tax credit, businesses in empowerment zones, or distressed areas, that hire and retain employees in that area can claim up to $3,000 per employee. The tax credit can be renewed annually and doesn’t limit the number of eligible employees.
- New Markets Credit: This tax credit helps revitalize struggling economies by offering a 39% tax credit over seven years to private investors who fund community development entities in low-income communities.
- Employee Retention Credit: Butler recommended exploring the Employee Retention Credit for small businesses whose operations were partially or fully suspended due to the COVID-19 pandemic. Companies can claim a refundable tax credit of up to 50% of $10,000 in qualifying wages for each full-time employee who you kept on your payroll in 2020 (up to a $5,000 credit for each employee). The value increases for 2021 wages, with 70% of qualifying wages of up to $10,000 each quarter (up to $21,000 credit for each employee).
[Read more: Claiming the ERC? Here’s What You Need to Know]
Too often, business owners focus exclusively on deductions and ignore the potential to claim equally beneficial credits.
Butler noted that now is the time to begin preparing your tax return to make sure you’re taking full advantage of the credits and deductions available. Consult with your accountant to see which of these credits you qualify for and make sure you’re not leaving any money on the table this tax season.
Here are additional tax credits that may benefit you as a small business owner.
Small Business Health Care Tax Credit
The Small Business Health Care Tax Credit is designed to help small businesses afford health insurance for their employees. If you have fewer than 25 full-time equivalent employees, pay average wages below the annual inflation-adjusted limit (for example, $62,000 in 2023), and cover at least 50% of employee-only premiums, you may be eligible for this tax credit.
The credit covers up to 50% of premiums paid (35% for tax-exempt employers) and is available to small business owners for two consecutive years. If you have fewer employees or lower average wages, you could receive a larger credit. You can even deduct premiums exceeding the credit and carry unused credits forward or back.
Credit for Small Employer Pension Plan Startup Cost
With employee retention and financial security in mind, the Credit for Small Employer Pension Plan Startup Costs helps small businesses offset expenses associated with establishing retirement plans like 401(k)s or SIMPLE IRAs.
Businesses with 100 employees or less that earn at least $5,000 annually may qualify. The credit covers 50% of startup costs, up to $5,000 per year, for the first three years of the plan. Eligible expenses covered by the credit include setting up, administering, and providing employee education on the plan. Additional credits are also available for businesses that add automatic enrollment features. You can use Form 8881 to claim this tax credit.
General business credit
Many of the credits within the IRS’s General Business Credit are designed to support small businesses. The collection of tax credits aims to incentivize specific business activities, such as investing in renewable energy, hiring certain workers, or conducting research and development. Rather than being a single credit, it combines multiple credits into one total amount to offset a company’s total tax liability.
Businesses can claim the credit using Form 3800. Unused portions of the credit can often be carried back one year or forward up to 20 years.
Employer Credit for Paid Family and Medical Leave
Businesses that provide qualifying paid leave to employees may be eligible for the Employer Credit for Paid Family and Medical Leave. To qualify, employers must offer at least two weeks of paid family and medical leave annually, with a minimum of 50% wage replacement, to employees who meet the Family and Medical Leave Act (FMLA) requirements.
Using Form 8994, employers can receive 12.5% to 25% of the wages paid, depending on the percentage of wage replacement provided. This tax credit is available through 2025.
Natural disaster tax relief
In addition to the array of small business tax credits, tax relief in disaster situations is available to help individuals and businesses impacted by severe natural disasters, such as winter storms, tornadoes, hurricanes, seawater intrusion, flooding, wildfires, and other severe storms.
A president has to declare an area as eligible for federal government assistance due to a major disaster, therefore declaring the area as a qualified disaster zone. Once declared, those in the area may be granted extensions for tax filing, payment deadlines, and additional tax relief measures. Disaster-related deductions due to lost or damaged property may also be available to qualifying businesses and individuals, leading to larger refunds.
Taxpayers may need to provide tax transcripts, which can be obtained online or by mail, to support disaster claims. The IRS waives fees and expedites requests for disaster-related amendments or applications for disaster benefits. If individuals need to temporarily change their address due to a disaster, they can notify the IRS using Form 8822.
Jamie Johnson, Emily Heaslip, and Lauren Kubiak contributed to this article.
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