With the passage of several tax acts over the last few years — and the enhancement of existing acts — small, medium, and large businesses are in a strong position to claim tax credits, at both the federal and state levels.
The credits are designed to foster economic growth and job creation, and business owners should be aware of them so they can take advantage of a political environment that is making it easier to obtain these tax credits, says Bill McDevitt, tax manager at Nichols Cauley & Associates LLC.
“Politically, both sides of the aisle have more recently been working together to create a positive climate for business owners. As a result, the number of tax credits available to businesses right now is abundant and the barriers to claiming them are fewer,” he says.
Smart Business spoke with McDevitt about how businesses should now be taking advantage of the tax credits available to them.
Are tax credits more valuable to business owners than tax deductions?
Often, they are. Credits are dollar-for-dollar reductions in the amount of taxes owed. For example, if your business qualifies for a $12,000 tax credit for expenses incurred to develop a new or improved product or process, the IRS may give your business a credit for having already paid $12,000 in taxes, and that amount is subtracted from the amount of tax owed on your company’s federal tax return.
Tax deductions, on the other hand, are expenses subtracted from your company’s income during the year that lower your company’s taxable income. An example of a deduction would include the cost of a new network server that the IRS may allow you to expense rather than capitalize in the year it is placed in service. Deductions are subtracted from income to arrive at taxable income, which is then used to determine the amount of tax you owe.
As a simplified illustration, assume your business is eligible for either a $12,000 tax deduction or a $12,000 tax credit. Which would you choose? If your company’s tax rate is 20 percent, the tax deduction may be worth about $2,400 after subtracting it from income to arrive at taxable income, and may only decrease the tax your business owes by $2,400. The tax credit, on the other hand, is subtracted dollar-for-dollar directly from the tax owed. So if the business made $100,000, subtracting $12,000 in deductions gets you a taxable income of $88,000, which, when taxed at 20 percent, means the company may owe $17,600 in tax. If, however, you chose a $12,000 credit rather than a deduction, the company may owe $20,000 in tax before the credit, but only $8,000 after $12,000 of the tax was paid with the credit. Choosing the tax credit rather than the deduction saved $9,600 in tax owed.
Are some tax credits only available to businesses of certain sizes?
While some credits are scalable to a wide range of businesses, others are limited to small businesses. For example, the Hiring Incentives to Restore Employment (HIRE) credit, which rewards employers for hiring and retaining employees, is allowed for large or small businesses. Also applying to businesses large and small: (1) the Work Opportunity Credit, a generous federal credit that encourages businesses to hire people from certain target groups — such as unemployed veterans, those with disabilities and convicted felons; (2) the Alternative Fuel Tax Credit, which may provide an incentive of 50 cents per gallon of alternative fuel sold by a retail dealer; and (3) the Georgia Retraining Credit, which allows employers to claim a tax credit for employee training.
In addition, the well-known Research and Development Credit has historically been pursued by larger companies, but new laws have made the credit cheaper and easier to obtain by mid-sized and smaller businesses.
Other credits, such as the Small Business Health Insurance Credit, only offer the maximum credit to employers with 10 or fewer employees who average $25,000 or less per year in wages. And the Small Employer Pension Plan Startup Cost Credit applies only to employers with 100 or fewer employees who received at least $5,000 in compensation in the preceding year.
Can tax credits offset Alternative Minimum Tax?
The HIRE credit cannot. However, the Work Opportunity Credit, Alternative Fuel Tax Credit, Small Employer Pension Plan Startup Cost Credit and the Research and Development Credit can. And in certain instances, the Small Business Health Care Tax Credit can also help offset Alternative Minimum Tax.
How can a business file for tax credits?
For the HIRE credit, employees simply complete an IRS Form W-11, ‘Hiring Incentives to Restore Employment Act Affidavit,’ which is kept on file with the employer and does not need to be sent to the IRS to certify the employee. Once the employee has been certified, the employer will file the easy-to-complete IRS Form 5884-B to claim the amount of the credit. This form is filed with the company’s federal income tax return.
For the Small Business Health Insurance Credit, an employer completes Form 8941 to calculate the credit and includes it with the company’s income tax return.
To claim the Work Opportunity Tax Credit, the employer should have the new hire complete IRS Form 8850 and U.S. Department of Labor Form ETA Form 9061 to obtain certification from its state work force agency that the new hire qualifies for the credit. These forms must be mailed to the state’s Work Opportunity Tax Credit coordinator no later than 28 days after the new hire begins work. The credit is claimed on IRS General Business Credit Form 3800 that is filed along with your company’s income tax return.
Filing these forms may seem like a complicated process, but is not. Given the favorable political environment to create jobs, this is low-hanging fruit that qualified business should take advantage of.
Bill McDevitt is a tax manager at Nichols Cauley and Associates LLC. Reach him at (404) 425-5338 or [email protected]