Tax season can be stressful, especially for professionals and small business owners. However, there are legal ways to significantly reduce your tax bill, and one of the most effective methods is through tax credits. Unlike deductions, which lower your taxable income, tax credits directly reduce the amount of tax you owe, dollar for dollar. Understanding and leveraging available tax credits can help you keep more of your hard-earned money.
In this article, we’ll explore the different types of tax credits available, how they work, and how you can use them to lower your professional tax bill.
1. What Are Tax Credits?
Tax credits are incentives offered by governments to encourage certain behaviors, such as investing in renewable energy, hiring employees, or providing health care benefits. Unlike tax deductions, which reduce the amount of income subject to taxation, tax credits directly lower the amount of taxes owed.
For example, if you owe $10,000 in taxes and qualify for a $2,000 tax credit, your tax liability would be reduced to $8,000.
There are two types of tax credits:
- Nonrefundable Tax Credits: These can reduce your tax liability to zero, but any excess credit will not be refunded to you. In other words, you cannot receive a refund for the unused portion of the credit.
- Refundable Tax Credits: These can reduce your tax liability to below zero, meaning that if the credit exceeds the taxes you owe, you may receive the remaining amount as a refund.
2. Types of Tax Credits for Professionals and Small Business Owners
Several tax credits are designed specifically to benefit professionals and small business owners. Below are some of the most common types.
A. The Work Opportunity Tax Credit (WOTC)
The Work Opportunity Tax Credit is available to employers who hire individuals from specific target groups, such as veterans, ex-felons, or individuals receiving government assistance. This credit can reduce your federal tax liability significantly, depending on the number of employees you hire from these groups and the hours they work.
- How to Qualify: You must hire from specific groups and submit the required paperwork within 28 days of the employee’s start date.
- Credit Amount: Depending on the employee’s target group and the number of hours worked, the credit can range from $2,400 to $9,600 per eligible employee.
B. The Research and Development (R&D) Tax Credit
If your business is involved in developing new products, processes, or software, you may qualify for the R&D tax credit. This credit rewards innovation and investment in research activities, even if the research does not result in a breakthrough.
- How to Qualify: Activities must be intended to develop new or improved products or processes. Costs such as wages, supplies, and contract research expenses can qualify.
- Credit Amount: The credit is generally up to 20% of qualified research expenses.
C. The Small Business Health Care Tax Credit
If you provide health insurance to your employees, you may qualify for the Small Business Health Care Tax Credit. This credit is designed to encourage small businesses to offer affordable health care coverage to their employees.
- How to Qualify: You must have fewer than 25 full-time equivalent employees, pay at least 50% of the premiums for their health care coverage, and your employees’ average wages must be less than a specific threshold (currently around $56,000).
- Credit Amount: The credit can cover up to 50% of your premiums if you qualify.
D. Energy Efficiency Tax Credits
Many governments offer tax credits to encourage businesses to invest in energy-efficient property and renewable energy sources, such as solar panels. If your business invests in green energy, you may be able to claim these credits.
- How to Qualify: You must invest in qualifying renewable energy sources or make improvements to your business property that increase energy efficiency.
- Credit Amount: The credit amount depends on the type of energy-efficient property or renewable energy investment made. The federal Investment Tax Credit (ITC), for example, allows for a credit of up to 30% of the cost of a solar panel installation.
E. Disabled Access Credit
If you make your business more accessible to disabled individuals, you may be eligible for the Disabled Access Credit. This credit is designed to help small businesses comply with the Americans with Disabilities Act (ADA).
- How to Qualify: You must have gross receipts of less than $1 million or fewer than 30 full-time employees. Eligible expenses include the costs of removing architectural barriers, providing interpreters, and acquiring accessible equipment.
- Credit Amount: The credit is 50% of eligible expenses, up to $10,250, with a maximum credit of $5,000.
F. Family and Medical Leave Act (FMLA) Tax Credit
If you offer paid family and medical leave to your employees, you may be eligible for the FMLA tax credit. This credit is available to employers who provide at least two weeks of paid leave to employees for family or medical reasons.
- How to Qualify: You must offer paid leave that is at least 50% of the employee’s wages.
- Credit Amount: The credit ranges from 12.5% to 25% of the wages paid to the employee during their leave, depending on the level of compensation.
3. How to Claim Tax Credits: Step-by-Step Guide
To maximize your savings, it’s essential to understand how to claim these tax credits. Here’s a step-by-step guide:
Step 1: Identify Applicable Credits
Begin by reviewing your business activities and expenses for the tax year. Determine which credits you may be eligible for, such as the R&D tax credit if you invested in new technology or the Work Opportunity Tax Credit if you hired employees from targeted groups.
Step 2: Gather Documentation
Each tax credit requires specific documentation to prove eligibility. For example, for the R&D credit, you’ll need records of wages paid to employees involved in research activities, receipts for research supplies, and contracts for outsourced research.
Step 3: Complete IRS Forms
Each tax credit has a corresponding IRS form that must be completed. For example:
- Work Opportunity Tax Credit: IRS Form 5884
- R&D Tax Credit: IRS Form 6765
- Small Business Health Care Tax Credit: IRS Form 8941
Ensure you complete these forms accurately to avoid delays or rejections.
Step 4: Apply Credits Against Your Tax Liability
Once you’ve identified your credits and completed the forms, apply the credits against your federal tax liability. Nonrefundable credits can reduce your tax bill to zero, while refundable credits may result in a refund if they exceed your liability.
Step 5: File Your Return
After applying the credits, file your tax return. Many credits, such as the Small Business Health Care Tax Credit, must be claimed through specific forms when filing your taxes.
4. Strategies for Maximizing Tax Credits
Here are some tips for getting the most out of your tax credits:
A. Hire Strategically
If you’re hiring new employees, consider hiring from groups that qualify for the Work Opportunity Tax Credit. Not only will you fill positions, but you’ll also reduce your tax liability.
B. Invest in R&D
Even if your business doesn’t involve technology, you may still qualify for the R&D tax credit by improving existing products or services. Keep detailed records of your research activities and expenses to claim this credit.
C. Provide Benefits
Offering health insurance and paid family leave not only improves employee retention but also opens the door to valuable tax credits.
D. Go Green
Investing in renewable energy sources like solar power can result in significant tax savings. Check if your state offers additional credits for energy efficiency.
5. Common Mistakes to Avoid
While tax credits can provide significant savings, there are some common mistakes to avoid:
- Failing to Keep Records: Most tax credits require detailed documentation. Without proper records, you may miss out on credits or face an audit.
- Overlooking Available Credits: Many small business owners don’t take full advantage of available tax credits. Make sure you’re aware of the credits that apply to your industry and activities.
- Missing Deadlines: Some tax credits, like the Work Opportunity Tax Credit, require you to submit paperwork within a certain time frame. Stay on top of deadlines to ensure you don’t miss out.
6. Consult a Tax Professional
Tax laws can be complex, and it’s easy to overlook credits that you may be eligible for. Consulting a tax professional can help you identify and claim all available tax credits, ensuring that you minimize your tax liability as much as possible.
Also Read: LLC vs S Corp: Which is Best for Minimizing Your Tax Burden?
The Bottom Line
Using tax credits is one of the most effective ways to lower your professional tax bill. Whether you’re hiring new employees, investing in research, or going green, there are credits available that can significantly reduce your tax liability. By understanding the types of credits available and following the steps outlined in this article, you can take full advantage of these savings opportunities.
With careful planning and the right documentation, you’ll be able to maximize your savings and keep more of your profits.