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Small businesses benefit from various tax credits that reduce the amount of tax they pay to the government. Here, we discuss tax credits, why they exist and provide a list of the top tax credits that small business owners should know.

Small Business Tax Credits

A small business tax credit is an amount of money subtracted from the taxes the business owes. Tax credits differ from tax deductions. For example, deductions cut a business’ total tax by a percentage of the deduction, depending on the tax bracket. Alternatively, tax credits reduce the tax due, not the amount of taxable income. In other words, a small business tax credit is a dollar for dollar deal – every dollar of credit cuts the business’ tax by a whole dollar. This credit is a significant benefit for small business owners because it helps recover some operating costs and retains the precious capital needed for growth.

As a practical example, if your business owes $20,000 in taxes, but you can claim a $5,000 tax credit, that amount is subtracted from your total tax bill making the new tax bill $15,000.

The Purpose of Small Business Tax Credits

The U.S. government grants tax credits to promote behaviors it finds favorable. For example, tax credits are offered to businesses as incentives for activities that benefit employees, promote specific industries, or aid or benefit society. One example is the government offering tax credits to businesses that purchase electric vehicles. The government encourages this to fight climate change and global warming. Because tax credits can have such a dramatic impact on a small business’s bottom line, it is crucial to stay apprised of tax credits for which your business is eligible.

7 Small Business Tax Credits for 2021

In the wake of the COVID-19 pandemic, related tax credits for small businesses top the list.

1. Employee Retention Credit

Under the American Rescue Plan, the Employee Retention Credit (ERC) is extended for small businesses through December 2021 and is available for all four quarters of the year. This tax credit allows small businesses to offset payroll tax liabilities by up to $7,000 per employee per quarter. That means a credit of up to $28,000 per employee is available for small businesses whose revenue declined due to the COVID-19 pandemic. A 20 percent decline in gross receipts during a single quarter makes a business eligible for this tax credit.

2. Paid Leave Credit

Another tax credit that falls under the American Rescue Plan is the Paid Leave Credit. This credit is extended through September 30, 2021, and offers credits for small and midsize businesses that offer paid leave to employees for COVID-related illness, quarantine, or family caregiving. The allowable credit is equal to wages up to $5,000 of paid leave for sick or quarantining employees.

Note: Small businesses are no longer required by law to offer paid leave related to COVID; however, if they do, the credit still applies.

Other tax credits of which small businesses should be aware are:

3. Health Care Tax Credit

With the Health Care Tax Credit, the smaller the business, the bigger the credit. The credit is highest for businesses with fewer than ten employees. Generally, the way to qualify for the credit is by enrolling in a Small Business Health Options Program (SHOP).

A business must meet the following requirements to qualify:

• (a) have fewer than 25 full-time employees,
• (b) have an average employee salary of approximately $50,000 per year or less,
• (c) pay at least 50 percent of full-time employees’ healthcare premiums, and
• (d) offer SHOP coverage to all full-time employees.

This credit can be claimed for two consecutive years, applicable from 2017 forward.

4. Work Opportunity Credit

This credit is available to employers who hire from specific groups that face barriers to employment. For example:

• Qualified IV-A Recipient – receiving TANF assistance
• Qualified Veteran – the IRS provides details of what “qualified” entails on their site under Tax Credits
• Ex-Felon
• Designated Community Resident (DCR) – between 18 and 40 years old and living in an empowerment zone, an enterprise community, or a renewal community
• Vocational Rehabilitation Referral – a person who has a physical or mental disability and has been referred to the employer while receiving or upon completion of rehabilitative services
• Summer Youth Employee
• Supplemental Nutrition Assistance Program (SNAP) Recipient
• Supplemental Security Income (SSI) Recipient
• Long-Term Family Assistance Recipient
• Qualified Long-Term Unemployment Recipient

Under the Consolidated Appropriation Act, 2021, this credit was extended until December 31, 2025.

5. Disabled Access Credit

Eligible small businesses that earn $1 million or less and have a maximum of 30 full-time employees in a year can claim this credit each year in which expenditures are incurred to make their business accessible to persons with disabilities under the Americans with Disabilities Act (ADA).

Expenditures include, but are not limited to, installing wheelchair ramps, upgrading restrooms, and providing Braille text materials.

6. Employer-Provided Childcare Facilities and Services

While few businesses these days seem to provide in-house child care for their employees’ children, a tax credit can make this an attractive option. This credit is a general business tax credit for 25 percent of qualified employer-provided child care expenditures plus 10 percent of qualified child care resources and referral expenditures. The credit is capped at $150,000 per tax year.

Qualifying expenditures:

• Include operating costs of a qualified child care facility
• Include costs for acquisition, construction, rehabilitation, or expansion of a property used as a care facility (but not land or any part of the principal residence of the taxpayer)
• May not exceed the fair market value of care provided

The employer-run facility must open enrollment to employees and must not discriminate in favor of highly compensated employees. At least 30 percent of the facility’s enrollment must consist of dependents of taxpayer employees.

7. Research and Development (R&D) Tax Credits

Several R&D tax credits exist for small businesses. These credits typically apply to science, medical and technology-based businesses; however, many businesses engage in qualified R&D activity.

The following activities qualify for an R&D tax credit:

• New prototype or model development
• Proprietary product on which you seek a patent
• Developing a new manufacturing process or business process
• Improving product efficiency or existing business processes
• Improving quality control processes
• Environmental or certification testing

Businesses that qualify for this credit can subtract up to 10 percent of R&D costs from their tax bill.

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Ask your tax professional about small business tax credits that apply to your business. There are additional federal small-business tax credits from state and local governments. Tax credits often expire after a few years, so act quickly to take advantage of those that apply to you.

The distinction may be challenging to make sometimes, but the IRS has very strict rules about it.

Depending on the size of your business, onboarding a new hire can involve a lot of reading and writing for both of you. You may want the new worker to fill out a personal profile. There could be a company handbook for the individual to read and detailed job specifications and a contract to absorb. And tax forms.

But which tax forms? That depends entirely on whether your new staff member is an independent contractor or an employee. The distinction involves more complex issues than their actual physical work location (your office or elsewhere) and their schedule (full-time 9-5 or an odd assortment of part-time hours).

The IRS takes this distinction very seriously. So seriously, in fact, that it’s been known to do lengthy investigations of large companies to determine whether staff members are being classified correctly.

You’ll need to determine whether workers are employees or independent contractors, so you know which tax form to send in January, a 1099-NEC or a W-2.

Three Factors

If you’re hoping for a magic formula that will help you make this determination, you’re not going to get one from the IRS. The agency does lay out the factors it looks at, but they’re somewhat murky. You have to look at three different elements of the relationship between management and workers as you try to make this call. They are:

• Behavioral. How do the workers do their jobs, and what do they actually do? Does the boss control this or the employee/contractor?
• Financial. Do workers pay for their own computers and smartphones and the other supplies and tools required to do their jobs, or does management? How are individuals paid? Are their expenses reimbursed? You’ll need to look at various aspects of the business relationship.
• Type of relationship. Will this be an ongoing relationship? Are there “extras” involved besides basic compensation, like employee benefits (health insurance, retirement plans, etc.) and written contracts? Will the new staff member be providing a work product that is a “key aspect of the business?”

What you’re looking closely at here is control. How much control does the boss have over employees or independent contractors?

You may get frustrated as you try to answer these questions. It may seem that some of your answers would indicate that the individual is an independent contractor, while others point to employee status. You might also discover that some of the individual’s work and workdays fit one definition while other work would indicate the other.

Like we said earlier, there’s no magic formula you can use to make this determination.

A Helpful IRS Form

If you absolutely can’t determine whether an individual is an employee or independent contractor, you can try to get help from the IRS by completing a Form SS-8.

You may find that you simply can’t make a determination based on how the IRS wants you to define your relationship with a specific worker. If that’s the case, you can complete and submit the multi-page IRS Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. This may help, but unfortunately, it takes roughly six months for the IRS to respond to your query. It may even take longer considering the slowdowns caused by the COVID-19 pandemic.

You’ll also have to contact your state’s labor office because each state has its own criteria for determining a worker’s status based on unemployment insurance and workers’ compensation laws. In addition to the questions the IRS poses, some states ask you to consider how economically dependent the person is on your business. Go to this page to find contact information for your own state’s labor offices.

Help With Onboarding?

If you’re in the process of hiring a new staff member or plan to during 2021, keep in mind that you’ll need to know immediately which IRS tax form you need to have them complete before you pay them for the first time. An independent contractor will get a W-9 (usually no taxes withheld) and an employee, a W-4 (taxes withheld).

Hiring an independent contractor is generally fairly easy. They usually send you invoices for their work. You pay them, and they’re responsible for their own income taxes. Onboarding an employee, however, is a more complex process, primarily because of the income tax piece. We encourage you to contact us if you’re having trouble distinguishing between employees and contractors and/or if you’d like help dealing with taxes for a new hire. We’ve worked with other small businesses in this area, and we’d be happy to assist you.

Eligible small employers who provide health care coverage to their employees can receive a Small Business Health Care Tax Credit from the Federal government. Here’s what you need to know about who qualifies and how to take advantage of the credit.

What is the Small Business Health Care Tax Credit?

Small business owners make numerous decisions about employee benefits. For example, the type of benefits offered can entice the most desirable candidates to apply for their company’s positions. The right type of benefits can also boost employee retention. An excellent employee benefit to consider is health insurance. If that’s a perk being offered, the small business health care tax credit is a feature of the Affordable Care Act (ACA) that may be of interest. The tax credit is limited to employers with less than 25 employees, and it operates as a sliding-scale credit based on the size of the employer. The larger the employer, the smaller the tax credit. The maximum credit is 50 percent of premiums paid (35 percent for tax-exempt employers).

Qualifying small employers can take advantage of the small business health care tax credit for two consecutive tax years providing the business owes no taxes during those years. The credit can also be carried forward or back to other tax years. Any excess amount paid for health insurance premiums over the allowable credit can be claimed as a business expense.

Who qualifies for the Small Business Health Care Tax Credit?

As mentioned above, the small business health care tax credit is for small employers with fewer than 25 full-time equivalent employees (FTE). Note that the FTE concept is based on hours worked rather than the actual number of employees.

Other qualifications include that:

The employer pays less than $50,000 a year per FTE in average wages. Determining FTEs and average annual wages should be done by your qualified tax preparer, CPA, or via guidance from the Internal Revenue Service (IRS).

The employer offers a qualified health plan to employees through a Small Business Health Options Program Marketplace (SHOP).

The employer pays at least 50 percent of the employee’s premium cost. (Not family or dependent premium cost.)

What about Tax-exempt Organizations?

Tax-exempt organizations are also eligible for the small business health care tax credit. In this case, the credit is refundable to the extent that it does not exceed income tax withholdings or Medicare tax liability. Refunds to tax-exempt organizations are reduced by the current fiscal year sequestration rate. For an explanation of sequestration and how it impacts the small business health care tax credit, consult your tax advisor or accountant.

How do small businesses take advantage of the Small Business Health Care Tax Credit?

To claim the small business health care tax credit, the IRS requires Form 8941 (Credit for Small Employer Health Insurance Premiums) to be filled out and submitted. For small businesses, the amount should be included as part of the general business credit on the company’s federal tax return. The amount should be included on Form 990-T (Exempt Organization Business Income Tax Return) for tax-exempt organizations. Note: this form must be filed for a tax-exempt organization to claim the small business health care tax credit, even if the business does not typically file that form.

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Small business owners may find that offering perks like health insurance aren’t beyond their economic reach with incentives like this. As always, a trusted tax professional is the place to turn regarding this and other tax credits for small businesses.

We’ve helped many individuals and businesses reduce their overall tax liability through proper planning. To learn more about our tax planning services, request a free consultation online or give us a call at (336) 354-4352.