Many small business owners miss or misunderstand the power of tax credits to build their businesses. If you read my column, you understand that a tax deduction is something that reduces how much taxable income you claim. A tax credit is something that directly reduces how much tax you owe.
A credit is a dollar-for-dollar benefit on your taxes, meaning that a $3,000 tax credit saves you $3,000 at tax time. Here are two common tax credits that many entrepreneurs simply don't know about that can save thousands of dollars.
1. Your research may qualify you for savings.
What comes to mind when you think of research and development? Large scientific or pharmaceutical companies, perhaps. But you may not realize that "qualified small businesses" can use something called the Credit for Increasing Research Activities to build your business and, potentially, increase your profit.
Whether your company needs to do R&D to develop new products or discover new methods for your existing operations, you may qualify for this tax credit, which can help underwrite the cost of research.
The key word here is "qualified."
A qualified small business is a corporation or partnership with gross receipts of less than $5 million for the current year and no gross receipts for any year preceding the fifth year prior to the current year. In other words, it's designed for young, growing businesses. For example, a business with $3.5 million in gross receipts in 2017 and no gross receipts prior to 2012 may use this option. This doesn't include a tax-exempt organization under section 501, so non-profits don't count.
If a business qualifies, you can opt to use the credit as an offset to the employer's share of Social Security taxes (up to $250,000) rather than using it against income taxes.
Qualified research is the next part of this equation. Think high-tech, new and improved. According to the IRS, this type of R&D must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer.
Research and experimentation might include an invention, patent, process, prototype, formula, technique, or similar product. In other words, it must be work to develop or discover something new. Lots of rules apply here, including what's not qualified, like research in social sciences, arts or humanities. It helps to have a tax pro advise you on this and you can find out more details in Form 6765, Credit for Increasing Research Activities.
2. Helping the unemployed may qualify you for more savings.
If you're an entrepreneur, know that you can do more than just feel badly about those who are less fortunate. You can give them a job and get a tax credit.
It's called the Work Opportunity Tax Credit (WOTC). This is a federal tax credit available for hiring individuals from certain target groups who have consistently faced significant barriers to employment. That includes our nation's veterans.
As I've written in a previous column, this is a win-win for small business owners and for our nation's unemployed. The maximum tax credit depends on the wages you pay to the new hire, that new hire's target group and the number of hours worked during the first year of employment.
As an employer, you can generally earn a tax credit equal to 25% or 40% of a new worker's first-year wages, up to the maximum for the target group to which the employee belongs. So if you hire a disabled veteran who has been unemployed for 6 months and is entitled to compensation for a service-connected disability, you as the employer are eligible for a maximum tax credit of $9,600.
To claim the credit, you need to ask for and be issued a certification for each employee from the state workforce agency (SWA) formerly known as the state employment security agency (SESA) of the state in which your business is located.
So while your tax pro searches for deductions for your business, make sure they are also up to date on tax credits. As a CEO or manager in your company, a dollar-for-dollar savings, courtesy Uncle Sam, can be a no-brainer for your bottom line.