Using Startup Tax Credits as Revenue for Your Business

Starting a business can be overwhelming. Navigating business taxes is one of the biggest tasks to tackle. And taxes sound very intimidating; for many entrepreneurs, taxes mean giving up all your hard-earned money to the IRS. But the reality isn’t quite that drastic, especially if you take the right steps.

Did you know that there are ways to improve your business revenue by taking advantage of tax credits? Here, we’ll cover some of the essentials you need to know about tax credits for small business owners.

Understanding Tax Credits

A tax credit directly reduces the amount of tax you owe to the IRS; in a way, it subtracts a certain amount from your total tax bill. That said, tax credits aren’t available to everyone; you have to qualify for them.

What’s the difference between a tax credit and a tax deduction?

A tax credit and a tax deduction are two different ways to reduce your tax liability, but they work in distinct ways. A tax credit is a direct reduction of the amount of taxes you owe. Meanwhile, a tax deduction reduces your taxable income, which in turn reduces the amount of taxes you owe because you’re paying a percentage of a smaller total.

For example, if you have a $1,000 tax credit, you will owe $1,000 less in taxes no matter how much your business income is. On the other hand, if you deduct charitable contributions totaling $1,000 for the year, your taxable income will be reduced by $1,000, which may result in a lower tax bill.

Ideally, you’ll be able to take advantage of a variety of tax credits and tax deductions, lowering your overall tax liability enough to benefit your business. But for the rest of this article, we’ll focus on tax credits, not deductions.

Identifying Tax Credit Opportunities to Improve Business Revenue

The U.S. government wants to inspire startups and small businesses to grow, develop, and strengthen our economy by issuing tax credits. However, less than two percent of those businesses take advantage and receive tax credits from the government. As a result, they collectively leave hundreds of billions of dollars on the table.

Tax credits are a type of tax incentive designed to reduce the tax burden on businesses and encourage economic growth. They lower the dollar amount of payroll or other taxes owed, so they can prove more valuable to small business owners than ordinary tax deductions. There are hundreds of these federal, state, and local tax credits.

Why do tax credits go under-utilized? They can be confusing and difficult to claim. The sheer volume alone is often daunting for small business owners. This can cause companies to miss out on funding opportunities.

Since many startups are not profitable, certain tax incentives may be unavailable to them. However, there are several opportunities to add to a revenue stream even before the company begins to turn a profit.

R&D Tax Credit

Research & Development (R&D) tax credits are available to any qualified business working on new, improved, or technologically advanced products or processes. The R&D tax credit is designed for new businesses seeking to bring new products to market in almost any industry. It is available to most startups in the U.S.

There are more than 50 R&D tax credit programs across the country and ample opportunity for a business to recoup some of the money spent on research and development. In fact, small businesses can see a six to 14 percent return. This could potentially add up to hundreds of thousands of dollars annually.

On average, businesses can save as much as $51,040, or between $3,000 and $6,000 per employee on payroll tax.

Work Opportunity Tax Credit

Companies that pay employees designated by a state workforce agency as people who have experienced “barriers to employment” may be eligible for the Work Opportunity Tax Credit (WOTC). These groups include but are not limited to:

• Veterans
• ex-felons
• summer youth employees
• individuals who have been unemployed long-term
• Supplemental Security Income (SSI) Recipients

Businesses with fewer employees may find it easier to qualify for the Work Opportunity Tax Credit, which can provide significant financial benefits.

According to the IRS, “the WOTC is equal to 40% of up to $6,000 of wages paid to, or incurred on behalf of, an individual who is in their first year of employment; is certified as being a member of a targeted group; and performs at least 400 hours of services for that employer.”

Retirement Plans Startup Tax Credits

An employer, particularly a small business owner, that offers retirement plans like a 401(k) or a simple IRA to its employees might be able to claim a credit of up to $5,000 for the costs associated with establishing those plans.

To qualify for the credit, the company must have:

• fewer than 100 employees who all were compensated at least $5,000 in the previous year
• at least one retirement plan participant who was not highly compensated

Other eligibility criteria includes employees not benefiting from another employer-offered “contributions or accrued benefits in another plan,” according to the IRS.

Health Coverage Tax Credit

For unprofitable startups, the Health Coverage Tax Credit can be especially attractive. It could help entrepreneurs recoup up to 50 percent of the premiums they pay on employee health insurance plans. By reducing the business expense associated with employee health insurance, the Health Coverage Tax Credit can positively impact a startup’s income.

To qualify for the credit, small businesses must meet the following criteria:

• fewer than 25 full-time employees
• an average annual employee salary of $56,000 or less
• the employer pays for at least 50 percent of the full-time employees’ health insurance premium costs
• the employer offers coverage to employees through a Small Business Health Options Program

Tax Audits to Pad Your Pockets

You might see the word “audit” and be intimidated. And that’s understandable. While the purpose of a Reverse Income Tax Audit (RITA) is to identify tax underpayments, it can also help small business owners identify opportunities to claim credits on state income tax overpayments. A Reverse Income Tax Audit can also help identify opportunities to claim credits on payroll taxes and other tax liabilities, further reducing the financial burden on small businesses. Many have found that this can be as much as 30 percent.

Typically, most companies that are in a state of transition qualify for RITA. This includes small businesses that are:

• in merger or acquisition mode
• have experienced multi-state sales
• are growing and diversifying new business activities and/or operations

Is the employee retention credit still available?

To encourage employee retention during the COVID-19 pandemic (and its aftermath), the employee retention credit was introduced. Eligible employers could make a claim for this federal tax credit if they had employees that they paid wages to and their businesses were affected by the pandemic.

The claim period for this tax credit passed, however. The credit was only issued for employers that paid qualifying wages after March 12, 2020 but before January 1, 2022. It’s not available for the current tax year.

How to Claim Tax Credits

Claiming tax credits can be a complex process, but it can result in significant tax savings. Here are the general steps to legally take advantage of available tax credits:

1. Determine eligibility: Check if you are eligible for a specific tax credit. Each tax credit has its own set of eligibility criteria, such as income limits, business type, or location. This applies to federal, state, and local tax credit options alike.
2. Gather required documents: Collect all the necessary documents to support your tax credit claim, such as receipts, invoices, and financial statements.
3. Complete the required forms: Fill out the required tax forms, such as Form 3800 for the General Business Credit or Form 8941 for the Credit for Small Employer Health Insurance Premiums.
4. Attach supporting documents: Attach all the supporting documents to your tax return, including receipts, invoices, and financial statements.
5. Submit your tax return: Submit your tax return with the claimed tax credit to the IRS.
6. Wait for IRS review: The IRS will review your tax return and verify the claim. If everything is in order, you will receive the tax credit.

It’s essential to note that tax credits can be complex, and the IRS may request additional information or documentation to support your claim. It’s recommended to consult with a tax advisor to help ensure you’re eligible for the tax credit and to help with the claiming process.

Tax software can also help you locate potential credits, but the process can be time-consuming. Getting professional assistance can help you maximize your refund.

The Bottom Line

Entrepreneurs and business leaders know that running and growing a successful business takes hard work, perseverance, and a solid support system. But securing money from the government should not take much heavy lifting; it’s there for the taking. All you have to do is see if you qualify, support your claim if you do, and take advantage. If in doubt, ask your tax advisor for help.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.