Savvy business owners should take every possible tax advantage. However, taxes can be confusing. There are over 2,600 pages in the Internal Revenue Code (IRC) and more are added every year by Congress. There are also thousands more pages of Regulations that help interpret the code. Complicating matters, parts of the tax code may require business owners to choose between two potentially advantageous deductions or credits, without any hint about which one is better for their situation.
Many companies affected by the COVID-19 pandemic took the Employee Retention Tax Credit (ERTC) to keep their doors open and employees on their payroll. Now business owners may be unsure how the ERTC interacts with other tax credits and deductions that they’re eligible for.
Whether your company qualified for the ERTC or not, the same principles apply for tax planning. Pre-planning for tax season will prepare a business to create programs, processes, or documentations that allow them to reduce their tax liability with tax credits and deductions.
Tax Credits Versus Tax Deductions
Given the choice, should you take a tax credit or a tax deduction? While it’s always a win to pay less in taxes, there is a difference between tax deductions and tax credits in a final bill. Tax deductions reduce your taxable income. Tax credits are applied afterwards and reduce your tax bill dollar-for-dollar.
But let’s see what that looks like in the real world.
If your company’s gross revenue is $100,000 with a 25% tax rate, but had a $10,000 tax deduction, you’d end up paying $22,500 in taxes.
If your company’s gross revenue is $100,000 with a 25% tax rate, but had a $10,000 tax credit, you’d owe $25,000 in tax, but only end up paying $15,000.
Tax credits, as you can see, provide a bigger boost to a business’s bottom line.
Which Tax Credits Can Companies Claim?
Tax credits provide the much needed capital that companies need to grow. Here are some of the most commonly claimed tax credits for businesses.
Paid Family and Medical Leave
IRC Section 45S is employer credits for paid family and medical leave. This section of the IRS code reimburses employers for wages paid out during an employee’s absence due to family or medical issues. If an employer claims this credit, they cannot include wages that were used for calculating any other general business credit in the determination of this credit.
Businesses affected by the COVID-19 pandemic can use the Employee Retention Tax Credit (ERTC) to offset the employer’s portion of the FICA tax. For disrupted businesses in 2020, employers could claim up to $7,000 per employee. For 2021, that amount was increased to $7,000 for Q1-Q3; all total, a company that experienced government shutdowns could receive $26,000 for keeping employees on their payroll.
The Work Opportunity Tax Credit (WOTC) is a federal tax credit for hiring employees who’ve faced significant employment barriers. The employees must be a certified member of a targeted group identified by the federal government, and this credit is limited to the amount of business income tax or Social Security tax owed.
Since 1981, the Research and Development (R&D) credit has rewarded American businesses who are investing in innovation with a dollar-for-dollar tax credit. Currently, 36 states offer an R&D tax credit as well, so companies that are able to claim both federal and state credits can maximize their tax credit potential.
Employer-Provided Child Care Tax Credit
Employers that provide child care for their employees can receive a tax credit for 25% of their expenditures on child care, plus 10% of child care resource and referral costs. Only licensed child care providers can be used by employers.
Credit for Small Employer Pension Plan Startup Costs
Businesses with 100 or fewer employees in the last tax year who haven’t yet set up a pension plan can use this tax credit to offset the cost of adding one to their business. 401(k) plans, SEP IRA and SIMPLE IRA plans also qualify for this credit. Employers will use Form 8881 to apply.
New Markets Credit
Open or build a business inside a Community Development Enterprise (CDE) or Community Development Financial Institute (CDFI) and receive a credit for the original investment amount by investing in a low-income area. CDEs and CDFIs are government-designated areas, and must meet certain thresholds to qualify.
Issues with Claiming Some Tax Credits Together
Many of the businesses that qualified for the ERTC, like restaurants, retailers, gyms, and service-based businesses, are also likely eligible for the wage-based WOTC. Since these industries were affected by the COVID-19 pandemic, it’s also possible that they took out PPP loans as well.
Other businesses that applied for the ERTC may also qualify for the R&D tax credit. Even though the ERTC is received as a cash refund, wages are used when calculating how much a company will receive in rebates. Employees who are engaged in qualified research activities have their wages included in the R&D tax credit calculation as well.
The general business credit Section 45S is used by employers who provide paid family and medical leave. For employers who offer this credit to their employees, they’ll receive a portion of the wages they paid to their employees while the employee was on leave.
The IRS does not allow what is known as “double-dipping”, or using the same wages to claim two different tax credits. Businesses who want to claim more than one tax credit should carefully separate their claims and clearly delineate which portion of the wages go toward each tax credit. Because each tax credit also uses different calculations, it may be beneficial to apply for tax credits in a particular order. Using an experienced tax preparer will maximize a business’s tax return when multiple credits are claimed.
Maximize the Business Tax Credits You Claim
Why would you ever want to leave money on the table? Reduce your taxes and maximize your tax savings when you openly collaborate with your financial team. Strike can complement your CPA or payroll provider to make sure that everyone understands which credits are being taken and which should be prioritized, which in turn will increase your tax savings. Strike works on a success-based fee structure–your success is our success.