Business Tax Credits: How Do They Work and How To Claim Them

Business tax credits reduce a business’s tax liability and stimulate businesses to participate in projects and campaigns the government finds constructive.

Tax credits work on a dollar-for-dollar basis and lower the sum you owe, as opposed to tax deductions that decrease your tax bill. That being said, it’s essential for businesses to check if they qualify for a tax credit for businesses, as they can opt for one of the available tax credits and directly reduce the taxes they owe.

In this article, we’ll explore the concept of a business tax credit, its types, eligibility criteria, and the benefits tax credits bring. Let’s start!

Key Takeaways

• Business tax credits lower companies’ tax rate liability. The government offers these credits as incentives to start a business, promote eco-friendly practices, and encourage equal job opportunities for target groups such as individuals with disabilities or veterans, among other purposes.
• Tax credits are dollar-for-dollar reductions on what you owe, whereas tax deductions reduce your taxable income.
• There are many types of business tax credits, such as general business credits, employee retention credits, employer-provided childcare credits, and more.
• To claim tax credits, you have to meet certain tax credit requirements depending on the tax credit in question, such as purchasing electric vehicles or providing childcare services and filling out forms on expected dates.

What Are Business Tax Credits and How Do They Work?

Business tax credits reduce taxes that a business owes. Specifically, the government can support initiatives businesses can take by offering them tax credits that directly reduce tax liability. For instance, your business may owe $100,000 in taxes. If you receive a $20,000 tax credit, you will owe $80,000.

Your business can take a refundable or non-refundable tax credit. A refundable business tax credit can generate extra income tax. For example, your business can owe a $2,000 tax. If you get a $2,200 refundable tax credit, your tax return will be at -$200, meaning you received an extra $200 from the government.

On the other hand, a non-refundable tax credit can cover the exact or partial amount of taxes your business owes. However, no extra income can be generated from non-refundable tax credits. With that in mind, let’s say you receive a $1,500 tax credit, and your business owes only $1,400. This non-refundable tax credit will only cover what your business owes (in this case, $1,400).

You can claim credits for the current year, retroactively for the previous year, and take credits for future tax returns. To do this, you must claim tax credits using forms like 3800 or specific tax credit forms while filing an annual tax return.

Business Tax Credit vs. Business Tax Deduction

A general business credit and other small business tax incentives differ from business tax deductions. First of all, business tax deductions lower a yearly tax income. There are many types of deductions a business can make, including:

• Payroll deductions
• Advertising and marketing
• Business insurance
• Education
• Miscellaneous deductions (legal and professional fees, etc.)
• Business meals

As said, such deductions lower your tax rate—you put all deductions together, calculate your tax income, and subtract the deduction amount from it to get the final tax rate you need to pay. To put this in an example, let’s say your tax income is $10,000 and your deductions are $3,000. The total amount you would need to pay is $7,000.

In contrast, you can lower your tax income by filing for tax credits. Business tax credits can cover either a part of or your entire tax income. For instance, your small business may owe $3,000 in taxes. If the government provides a $1,500 tax credit, what’s left to pay is $1,500.

Moreover, if you get a refundable credit, it can even lead to extra tax income. Let’s say your tax rate is $4,000, and you receive a $4,100 refundable tax credit—you will pay your taxes and have an extra $100 from the government.

9+ Types of Business Tax Credits

General business credit, work opportunity tax credit, and employer-provided childcare credit are only some of the business tax credits you can claim based on your business type and eligibility.

Let us explore the rest of the most widely known practices of credit tax savings for businesses.

#1. General Business Credit

General business credit is the sum of all the tax credits a business can claim in one year. It contains the carryover credits or provisions, which are tax losses from previous years. Also, general business credit includes the aggregate of all credits claimed in the current year.

If you are eligible, you must file a general business credit form (also known as Form 3800) to get one. As all the other tax credit types are part of the general business tax credit, businesses must use both Form 3800 designed for it, as well as the specific IRS tax credit forms for each additional tax credit they want to claim.

#2. Research and Development (R&D) Credit

Research and development (R&D) credit allows a dollar-for-dollar reduction of a business’s tax liability. The government credits small/medium businesses striving to make new, improved, and innovative products, formulas, procedures, software, etc.

To claim the R&D credit, business owners must fill out Form 6765, which consists of four separate sections (A, B, C, and D). You can generally apply 6% to 8% of your R&D expenses against tax liability.

#3. Work Opportunity Tax Credit (WOTC)

Work opportunity tax credit is a federal tax credit for businesses that employ individuals from targeted groups or people who have faced barriers to employment. Members of a work opportunity tax group include veterans, people with disabilities, etc.

Whether taxable or exempt from paying taxes, a business must get an official document from the State Work Agency (SWA) confirming that its hire belongs to a targeted group. Afterward, the employer must fill out Form 9061 and Form 9062. The former features information about the applicant's WOTC questionnaire, while the latter certifies applicants pre-inspected by the SWA.

Finally, employers must use Form 8850 along with the aforementioned forms to apply for a work opportunity tax credit.

#4. Employee Retention Credit (ERC)

The Employee Retention Credit (ERC) is a refundable tax credit for tax-exempt organizations and businesses that had employees and were struck by the COVID-19 pandemic. By presenting the ERC, the government wanted to encourage businesses to keep their employees on the payroll.

Employers whose businesses have been fully or partially suspended due to the pandemic or those with a decline in gross receipts of 50%+ qualify for this credit. Additionally, the credit covers a maximum of 50% up to $10,000 in wages paid by an employer.

Even though ERC stopped being active in late 2021, businesses can still get this credit for specific periods using amended forms. As the deadline (April 15th, 2024) to claim the ERC for the year 2020 has passed, only the businesses that qualify for this tax credit for the year 2021 can file the form until April 15th, 2025.

#5. Empowerment Zone Tax Credit

Empowerment zone tax credit is a variant of general business credit for employers whose employees work and live in the “zones”—underdeveloped, low-income areas. Its purpose is to encourage growth and development in the regions mentioned above.

Only for-profit organizations can claim this tax credit. It is worth 20% of wages paid up to $15,000 per annual accounting period, with a maximum annual credit per employee of $3,000. To qualify for this credit, a company’s employees must live and work in one of the “zones” for at least 90 days.

The central “zone” cities are:

• New York, New York
• San Antonio, Texas
• Jacksonville, Florida
• Los Angeles, California
• Chicago, Illinois

#6. Energy Efficiency and Renewable Energy Tax Credits

Energy efficiency and renewable energy tax credits, or energy tax credits, help businesses that use alternative energy sources lower their tax bills. Most of the time, businesses do not receive energy tax credits in advance. Instead, they get some of their investments back after spending funds on energy saving and pollution reduction.

Three of the most well-known energy tax credits are:

• Investment tax credit (ITC)
• Production tax credit (PTC)
• Energy efficient commercial buildings tax deduction (EECBP)

The ITC and the PTC provide a deduction for installing renewable energy systems. Similarly, the EECBP offers a tax deduction for businesses that install energy-saving equipment. You need to fill out and send your tax documents, specifically Form 5695, to claim this credit.

#7. Small Employer Health Insurance Credit

Small employer health insurance is a tax credit for small businesses. It is one of the health tax credits employers can use for two consecutive years.

Before they claim it, businesses must meet the following criteria:

• Have fewer than 25 full-time equivalent employees.
• Pay annual wages that are less than the inflation-adjusted sum for your employees.
• Offer all your full-time employees a health plan or shop coverage.
• Pay 50%+ for the employee-only premium costs.

The smaller your business is, the bigger the business tax credit for health insurance you can get. Therefore, small businesses can claim a maximum of 50%, and tax-exempt employers can claim up to 35% of premiums paid.

#8. Plug-In Electric Drive Vehicle Credit

The plug-in electric drive vehicle credit is a business tax credit for cars or vehicles. Both owners and manufacturers are eligible for this credit. Some vehicles grouped under the plug-in category are two-wheeled, light trucks, and passenger vehicles.

The amount of credit businesses can receive depends on the year of purchase, vehicle battery capacity, and its components. If they pass the Internal Revenue Code 30D check, employers can file Form 8936 and receive up to $7,500 of credit.

#9. Employer-Provided Childcare Credit

Employers who pay for their employees' childcare expenditures to provide childcare services over the tax year are eligible for this credit. The maximum employer-provided childcare credit a business can receive is $150,000.

This credit covers two elements of childcare services up to a certain percentage, including:

• 25% of the qualified childcare facility expenditures you incurred or paid during the last tax year.
• 10% of the qualified referral expenditures and childcare resources you incur or pay throughout the tax year.

Businesses must use Form 8882 and the Credit for Employer-Provided Childcare Facilities and Services form to claim this credit.

#10. Family and Medical Leave Tax Credit

Family and medical leave tax credit is a general business credit for which employers qualify based on wages paid to employees during their sick or family leave. The credit value is between 12.5% and 25% of what employers pay to their employees while they are on leave for 12 weeks per tax year.

You can qualify for this business tax credit if you:

• Paid for 50%+ of your employees’ regular wages during their leave.
• Your payroll documentation shows your employee has been with the company for a year or longer.

Employer Credit for Paid Family and Medical Leave and Form 8994 are must-haves for claiming this type of credit.

Who Is Eligible for a Business Tax Credit?

Business tax credit eligibility depends on various factors, such as the company's size, industry, activities, documentation, and more. Each type of business should check whether it is eligible for one or more tax credits.

For instance, the company's size is key to being eligible for certain tax credits like the Small Employer Health Insurance Credit. This is because a company must have fewer than 25 full-time employees to qualify for it.

The reason why industry is an important factor in tax credit qualification is that some sectors have become obsolete while others are in demand. Therefore, it is not surprising that the government offers tax credits to electric car manufacturers and the ones who buy such vehicles, as it largely encourages the creation of an eco-friendly environment.

Sometimes, a business's operations can qualify it for a tax credit. While not all businesses operate the same way, those paying more attention to employees’ well-being (e.g., providing benefits like qualified expenditures) have a higher tax credit eligibility.

On top of this, being up-to-date, preparing neat payroll documentation, and being generally responsible when taking legal and financial action are good ways to enhance business tax credit eligibility.

3 Benefits of Business Tax Credits

Business tax credits are beneficial for multiple reasons—they reduce tax liability, encourage the growth of non-developed or new industries, promote technological advancement and innovation, create a safer environment, and motivate businesses to provide individuals from targeted groups equal opportunities.

Let’s take a closer look at the three main benefits of business tax credits:

#1. Reduced Tax Liability

Reduced tax liability is one of the main benefits of business tax credits, as they lower the amount of money companies need to pay for taxes. Lower tax rates bring higher chances of avoiding financial crises and staying far away from bankruptcy, especially during emergencies. In addition, a decreased tax income makes general tax planning easier.

#2. Encouraged Growth

Business tax credits are made to help both small and large businesses grow. The lower a company’s tax income, the more funds it can use to invest in its equipment, pay higher salaries, and improve overall development. And yet, the more a business uses funds for such purposes, the higher the potential profit it can get.

#3. Innovation, Development, Fairness, & Safer Environment

Companies that use business tax credits can become more developed in the sense of innovation and technological advancement. Likewise, new-age technology provides environment-friendly tools, machines, devices, and vehicles.

Last but not least, a set of tax credits encourages businesses to promote equality, equity, and fairness. This means that every individual from targeted groups will have an opportunity for employment and equal labor rights.

How To Claim Business Tax Credit

To claim business tax credits, you should make sure you’re eligible, use the right forms, and respect the deadlines. Before all else, we recommend checking the list of business tax credits, as it can help you choose the one that fits your business best.

Your company's requirements for getting tax credits will vary depending on the credit type. In other words, you should apply for a tax credit that correlates with your company’s working policy, as this can directly benefit your company.

Once you find a suitable tax credit for your company, filling out the right forms is essential. Every tax credit type comes with its own form. Usually, you have to submit additional forms along with the self-titled form for a tax credit. For example, you must fill out Form 9061 and Form 9062 before submitting the final Form 8850 for WOTC.

Lastly, the latest dates you can claim a tax credit for your business are generally:

• 2 years after paying the tax
• 3 years after filing for your federal tax return

Tax Preparation as a Starting Point

Tax filing and document preparation stop being time-consuming and overwhelming with the right tools. Using Paystub.org, employers can create numerous paystubs and invoices in just a few clicks, automatically streamlining the entire process.

Aside from creating paystubs, you can also use our W-2 and 1099 generators to create your documents quickly and stress-free.

Final Thoughts

Business tax credits lower companies’ tax liability. The government provides tax credits to motivate employers to use eco-friendly production and service tools, employ people from targeted groups, and grow their businesses.

Many types of tax credits are available for different sorts of businesses (e.g., tax credits for small businesses, health insurance, work opportunity tax credits, and more.). To claim one of them, your business must meet the eligibility criteria for each type of credit.

Tax preparation is key. Paystubs.org offers tools that allow you to generate tax documents quickly and avoid missing key elements during the process.

Business Tax Credit FAQ

#1. Are business tax credits refundable?

Some business tax credits are refundable, and some are not. Depending on your business type, you may find either refundable or non-refundable tax credits or both.

#2. What happens if a tax credit exceeds tax liability?

If a tax credit exceeds tax liability, you may or may not be able to keep the additional funds. This directly relates to the type of credit you claim—you can keep additional funds if you receive a refundable tax credit but cannot do so if you get a non-refundable one.

#3. Can startups or small businesses claim these credits?

Startups or small businesses can claim business tax credits. Yet, they must meet all the criteria and file appropriate forms while respecting the deadlines.