Author: Ronica Brown | Estimated Reading Time: 1 minute
A client came to me a few years ago with $907,000 in taxable income.
The only thing he was doing to pay less taxes as a business owner was contributing to a SEP IRA.
My team and I helped him save $197,000 in taxes partly because of the tax credits we helped him apply for. He moved from a $289,000 tax bill to a $92,000 tax bill. That’s 68% in tax savings!
Here’s the truth.
Tax credits are game-changers for business owners. There’s rarely a tax savings plan that doesn’t include various types of tax credits.
Hundreds of tax credits are available. But a lot of business owners don’t even know they exist. That’s why I’ve included some of the most popular tax credits in this article. It’s best for you to be informed so that you can have a discussion with your existing CPA about the tax credits that could work for you.
I want you to learn as much as possible about tax credits so that you can use them as part of your tax strategy.
Key Takeaways
Tax credits provide a dollar-for-dollar reduction on your tax bill.
There are tax credits that can provide you with a return on investment.
You can get tax credits based on the number and types of employees you have.
Tax planning is what helps you truly maximize the tax credits that work best for your business.
What Are Tax Credits?
The US government provides a range of tax credits for business owners that can help you significantly reduce your tax bill. Tax credits allow you to claim a dollar-for-dollar reduction on your taxes and are, therefore, hidden sources of cash for many small businesses.
The key to maximizing the benefits of tax credits is to understand the tax credits that apply to your business. Some tax credits are specific to certain states, industries, and taxpayer classifications.
Tax Credits Vs. Tax Deductions
Tax credits differ from tax deductions because they actually reduce your tax bill dollar-for-dollar. Tax deductions only reduce your total taxable income.
Here’s an example.
Let’s say your business income for the year is $10,000. With a $3,000 tax deduction, your taxable income would be reduced to $7,000 and you would only be required to pay $703 in taxes.
Let's say your business income is still $10,000, but this time you received a $3,000 tax credit. In this example, your tax bill is $1,040 but since you have this credit, the $3,000 credit will cover this tax bill then produce a tax refund.
So, the tax deduction reduces your taxable income but the tax credit actually reduces the taxes you owe. In some instances, it can even wipe your tax bill out altogether and put money in your pocket.
If tax credits offer such amazing benefits, why then do many people focus so much attention on tax deductions? The truth is a lot of people don’t know about tax credits and the requirements for getting tax credits for their business. They don’t have a tax strategy. So, they waste money on deductions which inevitably reduces their overall cash flow.
What Are The Types Of Tax Credits?
There are two broad categories of tax credits: refundable and non-refundable tax credits. Refundable tax credits allow you to get a refund of the balance of the credit. In our example, if this $3,000 credit was a refundable credit so the IRS would send you a check for the refund amount of $1,960.
On the other hand, a non-refundable tax credit allows you to use the credit to cover the amount of taxes you owe. You won’t get a refund for this amount. For some non-refundable tax credits, this amount is lost and some of them can be carried forward into the next tax year.
There are two other types of tax credits that fall within refundable and non-refundable tax credits. The first is automatic tax credits. You don’t have to do much to get these tax credits because they may be based on life events, income limits, or other facts that are normally on your personal tax return.
Some examples of automatic tax credits include:
Child Tax Credit
Earned Income Credit
Dependent Care Credit
Education Credits (Lifetime Learning and American Opportunity Tax Credits)
Retirement Saver's Credit for those who contribute money to retirement and earn below an income limit per year.
Energy Credits such as buying a Tesla or making energy-efficient improvements
These automatic tax credits are available based on life events.
The second type of tax credit is what I call credits from tax planning. These tax credits require a credit analysis and submission of paperwork before the tax credit is issued. All business credits fall into this category.
How Can You Get Business Tax Credits?
Business tax credits are generated by the use of resources such as cash or personal or business assets. The best business tax credits are those that don’t require extra cash but are instead generated by the activities in your business. In other words, you’re already spending that money for normal business activities but it also triggers an opportunity for a tax credit.
Business tax credits are available at both the state and federal levels. So, if you don’t get a federal tax credit, chances are you can get a state tax credit. You could even qualify for both. The goal is to know that these tax credits exist so that you can rightfully claim them.
What Activities Trigger A Tax Credit?
Various activities trigger a tax credit for your business depending on the type of tax credit. So, I’ll explain these activities within the context of the three main groups of tax credits: syndicated tax credits, federal income tax credits, and state-based tax credits.
If you believe any of these credits may fit your business, speak with a tax advisor or consult a tax credit expert. Your tax advisor won’t know all the details of every tax credit that exists. But it’s your tax advisor's job to help you find a tax credit specialist who can help you correctly utilize the best tax credits for your business. A tax credit specialist will do a complete analysis of our business profile and provide:
A list of credits you would qualify for
Changes you need to make to meet the requirements stated to benefit from the tax credits
A list of state-based incentives that are available
So, let’s dive in.
Tax Planning with Tax Credits
You can purchase tax credits to reduce your taxes and receive an ROI. Tax credits that offer both benefits are called syndicated tax credits. They’re important because they allow you to trade your tax dollars for an investment in a company.
These tax credits are offered as one-time transactions for businesses. You either purchase the credit at a discount to help cover your taxes or you get an offset for additional funds spent to reduce your taxes. Examples of these credits include film tax credits, investment credits, renewable energy credits, and oil and gas credits.
As an investor, you can use these tax credits to participate in an industry that you believe in, earn an investment return, and reduce your taxes. For example, let’s say you owe the IRS $100,000. Instead of paying all of that money to the IRS, you can invest up to 75% of this amount ($75,000) in a solar company.
WORD OF CAUTION: This company must be in the business of installing and maintaining solar power in commercial buildings and solar farms across America. So, this investment doesn’t include buying solar for your home.
In this example, your tax bill is $100,000. Your options are to pay that $100,000 in taxes or invest in one of the tax incentive programs (the solar company in this case). If you choose to invest in one of these programs, you only pay $25,000 in taxes.
The solar company will then issue you $75,000 worth of deductions and tax credits to show the IRS that your $100K in taxes is fully accounted for. But the real benefit comes from your $75,000 investment helping you receive income over the life of your contract with the solar company. You’re making money!
Other tax credits used in tax planning include:
Other Renewable Energy Tax Credits
Historic Tax Credits
Historic Rehabilitation
Low Income Housing Tax Credits (LIHTC)
Federal Income Tax Credits
Federal income taxes are offered regardless of the state in which your business is based. There are hundreds of federal tax credits. I couldn’t discuss all of them in one article. So, I’ve listed them below:
Research and Development (R&D) Tax Credit
Small Employer Health Tax Credit
Employee Training Tax Credit
Employee Retention Tax Credit
Work Opportunity Tax Credit
Differential Pay Tax Credit
Disabled Access Tax Credit
New Markets Tax Credit
Employer-Provided Child Care Tax Credit
Tax Credit for Employer-Paid Family and Medical Leave
Employer Tip Tax Credit
Rehabilitation Tax Credit
Small Employer Pension Plan Credit
You can discuss these, and other federal tax credits, with your tax advisor to determine which would be right for your needs.
State-Based Tax Credits
Each state offers different types of tax credits. These tax credits have two important considerations. First, they are based on the industries in which your state is investing in to facilitate growth. Second, you have to carefully look at the activities of your business and whether they align with these state-wide investments. If they align, there’s a greater possibility that you’ll qualify for these tax credits.
Most state tax credits typically fall into one (or more) of the following categories.
Industry Growth Credits
Do you actively participate in business-related activities unrelated to your core business offerings? You could benefit from industry growth tax credits. For example, the state of Georgia invested a lot in the TV and film industry coming to Georgia. The production companies received a lot of state tax incentives to produce films in the state.
Taxpayers could purchase film credits at a discount to offset their taxes. Let’s say you owed $30,000 and you purchased film credits that amounted to $25,000. The film credits would provide you with $30,000 worth of credits to offset your complete tax liability. Instead of paying the state $30,000, you would only pay $25,000. That results in $5,000 tax savings.
Film credits are just one type of industry growth credit. These credits will differ based on the unique growth needs of each state.
Other incentives similar to this would be programs that give you a business tax deduction as well tax credit to offset your taxes. The GA Kids First Scholarship Program is an example. Businesses that participate in this program can deduct up to $10,000. Here’s how it works:
1) Your business gets a tax deduction of $10,000.
2) If your tax rate is 35%, this will result in $3,500 in tax savings.
3) You then receive a $10,000 state tax credit on your personal return to offset your personal taxes.
This incentive works best for individuals who own a business that is taxed as an S-corporation or partnership and now have a state tax payment of over $20,000 (married) or ($15,000) single.
The other option is to just pay the state directly without going through this program. If you paid the state directly, then you spend $10,000 to pay your state taxes with no deduction. This credit is especially important if your real estate property tax and state tax income are over $10,000 (Married) or $5,000 (single). This limit is important because you are not able to write-off on your personal return over these limits in taxes.
These credits aren’t unique to the state of Georgia. You can check your state’s website to find applicable credits.
Job Creation and Retention Tax Credit
This tax credit is usually for growing businesses that hire a certain number of employees annually. Some states also provide incentives for employee retention or if an employee moved from out-of-state to work for your business.
Employee Training and Development
This tax credit is available for your employees to get trained in your business. So the cost of time spent on training and development of your employees will qualify for a tax credit. The type of training is not limited, it can be as simple as software updates to the software of tools that are being used in your business, onboarding training for new employees, and more.
Business Growth Tax Credit
States also offer research and development tax credits that relate to business growth. These tax credits aren’t limited to new products or inventions. They also include improvements to business processes.
Location-Based Tax Credit
State tax credits can also be based on curtained zones where the local government believes new investments are needed. An empowerment zone is a good example of a curtained zone.
According to the US Department of Housing and Urban Development, “empowerment zones are designated areas of high poverty and unemployment that benefit from tax incentives provided to businesses in the boundaries of the EZ.” So, you could qualify for a location-based tax credit if your business operates in an empowerment zone.
How Can Tax Planning Help You Access These (And Other) Tax Credits?
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A full review of your business is done during tax planning so that we completely understand the tax credits for which you qualify. My team and I are normally able to identify at least two to three tax credits for most of our clients. Our tax planning helps you understand the best tax credits to move forward with, as well how much in tax dollars you’ll receive from your tax credits.
Business owners tend to make two mistakes:
Assuming a tax credit won’t work for them
Seeking advice from someone who doesn’t know much about a specific tax credit
The tax code is extremely complex. So, some things, like tax credits, require specialized knowledge. Also, the requirements and laws for tax credits change often. That’s why we work with numerous specialists in this tax credit space who know the details of these credits and can complete a comprehensive analysis.
Most CPAs will provide a tax credit recommendation after spending five minutes on Google. My team and I saw this happen with the retention credit that was offered by Congress at the height of the COVID-19 pandemic. A lot of business owners lost out on this tax credit because their CPA told them they didn’t qualify (due their lack of experience with this credit), or they didn’t tell their client about this credit at all.
My team and I helped our clients maximize the benefits of the retention credit because we worked with specialists who understood how to apply the credit. That’s why it’s important to work with a team who understands how to do tax planning collaboratively so that you can receive tax credits that work well for you and put more money into your pocket.
Final Words
Tax credits are important for the success of a tax savings plan. Saving a whopping $197,000 in taxes often isn’t possible without the use of tax credits.
Of course, your tax savings will depend on the unique characteristics of your business. But there are numerous tax credits available so that you can benefit from a dollar-for-dollar reduction on your taxes. There are even some, like the syndicated tax credit, that allow you to get a ROI from your tax savings.
I hope you learned something from this article. If you have any questions about applying tax credits to your tax savings plan, feel free to contact me.