What is a Tax Credit? A Guide to Business Tax Benefits

Taxes are an inevitable part of running a company. However, you may be able to reduce your tax liabilities with certain tax benefits. These types of business tax credits differ from tax deductions, although they're not as widely known. Many small businesses miss out on tax credits that are available to them. Let’s explore the differences between tax credits and deductions, and provide tips to help your small business reduce its tax bill.

What is a Tax Credit?

A tax credit refers to a certain amount of money that small businesses can subtract from the taxes they owe to the federal and state governments. It's different from a tax deduction:

• A tax deduction lowers the amount of your business’s taxable income. If you spend $5,000 on office equipment, it's deductible. But it doesn’t mean your tax bill will be $5,000 less. The money you save depends on your tax rate and other details related to your business. 

• A tax credit reduces your tax bill dollar for dollar. If you owe $10,000 and qualify for a $3,000 credit, you now only owe $7,000. That’s why, for small business taxes, some tax credits carry more weight than deductions. Certain tax credits are even refundable, meaning you could get money back if the credit exceeds what you owe. 

Understanding the difference can help you transform tax season into an opportunity for financial savings. 

Common Tax Credits for Small Businesses

Many small businesses are unaware of the benefits available to them, and others mistakenly believe that tax credits are only for large corporations. In reality, small businesses have access to some of the most valuable business tax credits. Here are some examples:

• Research & Development (R&D) Tax Credit: If you’ve spent money improving processes or developing new products, you may have R&D expenses that count. 

• Work Opportunity Tax Credit (WOTC): If you hire veterans, individuals with long-term unemployment, or those from other targeted groups, you can claim the Work Opportunity Tax Credit for a portion of their wages. It offers a financial break and a way to expand your workforce.

• Small Business Health Care Tax Credit: If you have fewer than 25 full-time employees with wages below $62,000 per year and contribute to the premiums, you may qualify. This tax credit can offset the costs of your health insurance contributions.

• State and Local Tax Credits: Many states offer tax credits for job creation or training. They may also support investment in underserved areas. These tax credits vary widely, so check with your local tax agency to see what applies to you.

Tax credits can work wonders in reducing your tax bill. Take some time to find ones that work for your business and apply for them.

How to Qualify and Apply for Business Tax Credits

One of the difficulties may be figuring out if you qualify or not. Business tax credits require documentation that ties the credit back to real business activity. That could mean payroll records for the WOTC or contribution records for your health insurance premiums. You also have to apply for each tax credit.

The IRS requires you to fill out specific forms for each tax credit. They sometimes include extra instructions. For example, you need to pre-screen new hires with IRS Form 8850 before you can claim the WOTC. Miss this step, and you won’t be eligible for the credit. Other credits may involve follow-up reports or audits.

One common mistake is waiting until tax season to consider business tax credits and apply for them. By then, it’s harder to piece together the records you need, and you may miss some deadlines. It's a good idea to track business tax benefits you’re eligible for throughout the year. 

Reduce Your Company's Tax Liability

What makes credits a powerful business tax benefit is how they impact what you owe in your company’s gross income taxes. For many small businesses, this can be the difference between investing in expansion or simply covering costs. Business tax credits enable you to offset certain costs and keep your money within the business. 

Credits can also cushion surprises. Maybe payroll ran higher or operation costs spiked this year. When you qualify for business tax benefits, you can put these savings toward your other costs. They provide you with the financial flexibility to make informed decisions.

Maximize Tax Credit Opportunities for Business Growth

Business tax credits become more valuable when you fold them into everyday planning. Here are a few ways to do that:

• Keep Records in Real Time: Document qualifying expenses as they occur. It’s much easier to keep up with expenses as you go rather than chasing a paper trail months later.

• Look for Overlaps With Your Goals: If you’re already expanding your team or upgrading equipment, check if there are credits that apply to you. Aligning your goals with available tax credits saves you money.

• Decide Where Savings Go: The savings you receive from tax credits can be reinvested in your cash flow or allocated toward a specific purpose. This flexibility allows you to focus on what you want for your business.

• Stay Ahead of Tax Updates: Federal and state rules shift frequently. Being aware of the updates ensures you don’t miss out when new opportunities emerge. It also helps reduce tax compliance risks.

• Get Professional Support: Consider partnering with a Professional Employer Organization (PEO). When you're selecting a PEO that manages payroll, benefits, administrative tasks, and HR compliance in one place, it simplifies the documentation to apply for tax credits.

Streamlining Tasks and Documentation With Justworks

Business tax benefits enable you to retain more of your business's earnings. The hurdles are often time constraints to research them and the required documentation to claim them. The right tools and software can give you a leg up.

Justworks PEO helps you keep your payroll and documentation organized. Additionally, you gain access to other time-saving HR tools and features, such as employee hiring and onboarding. Ready to simplify your payroll tax records and get the backup you need? Get started with Justworks today.