Guide to U.S. Small Business Tax Incentives

As a business owner, it’s important to know about federal, state, and local taxes. Not only does this ensure you meet legally mandated tax payments and reporting requirements — but it can also save you money in the big picture, thanks to tax incentive programs. But just what are tax incentives?

Tax incentives are deductions, exclusions, and exemptions you can claim from tax money owed to the United States government. The government provides incentives to encourage people and businesses to undertake certain activities that support U.S. economic growth. For example, tax breaks might reward a business for job creation.

You might hear these incentives referred to as "tax breaks." In particular, small business owners can tap into these opportunities to retain more of their profits, nurture growth, and promote long-term stability.

What Is a Tax Incentive?

Tax incentives come in various forms, including:

• Tax exemptions , meaning you don’t have to pay specific taxes.
• Tax reductions , meaning your tax burden is decreased, and you don’t have to pay as much in taxes.
• Tax refunds and rebates , in which your business gets back a portion of taxes paid.
• Tax credits , which are like "points" that can be accumulated and used when tax season rolls around.

All of these tax incentives share one thing: They reduce tax rates on the business. Why would the government do this? A few reasons include:

• To promote environmentally friendly business practices. For example, take the Federal Investment Tax Credit for Commercial Solar Photovoltaics. This gives business owners a solar investment tax credit (ITC) for qualified expenditure on environmentally friendly solar energy. Businesses that start building construction on a solar photovoltaic system in 2021 are eligible for a 22% ITC.
• To encourage businesses to invest back in the economy. Tax incentives can also be local- or state-based. For example, Pennsylvania offers a Rural Jobs and Investment Tax Credit (RJTC) program to motivate business owners to invest in less-populated areas, creating new jobs and stimulating economic development. Many states have similar economic development incentives in "enterprise zones." New York and Nevada have "opportunity zones," for example
• To support disadvantaged business owners or minorities. The Minority Business Development Agency (MBDA) is a federal initiative providing tax incentives for using minority-owned businesses. According to federal language, "minority" is defined as a business with a minority controlling at least 51% of its operations. (The federal definition of "minority" includes women, Alaska Natives and Native Hawaiians, Asian Americans, Black and African Americans, American Indians, and Hispanic persons.)

These are just a few examples. The government can design tax incentives around set goals, from increasing research and development to workforce development.

Tax Incentives for Small Businesses

Some tax credits are available to all types of businesses, regardless of their size. However, a number of tax incentives are designed for self-employed individuals and small businesses.

Why does the government care about small businesses? They are traditionally considered the backbone of U.S. economic activity. Small businesses drive local job growth and reinvest in their communities. They serve places that large corporations may overlook.

What are tax incentives for small businesses? They can reward you or your company for taking certain steps to improve your business operations or help your workers. When you claim these tax breaks, you reduce your tax bill, meaning the amount of tax you pay is less. Below, we provide an overview of some of the most common tax breaks for small businesses.

Health Insurance Premiums

Health insurance premium credits reward businesses for paying premiums for their employees’ health care coverage. You can get a credit of 50% of the premiums you’ve paid. However, you must have paid at least half your workers’ premiums to qualify. There are other criteria, too. First, all employee coverage must have been purchased through the Small Business Health Options (SHOP) program.

Additionally, you can’t employ more than 25 full-time employees or the equivalent of 25 full-time employees, and you can’t have a payroll exceeding a set amount ($53,400 as of 2018). This number is adjusted regularly for inflation. Finally, this credit can only be claimed for two tax years in a row. So, if you want to take advantage of this credit on your 2021 tax return, you can’t have claimed it in 2019 and 2020. See Form 8941 for more information.

Pension Plans

If you start a pension fund for your employees, you can get tax credits for the expenses needed to establish and manage the fund. You can also get coverage for the cost of educating workers about the fund. If you’re eligible, the credit is eligible for the first three years after you institute the pension plan. It covers half your expenses up to $1,000.

The Small Employer Pension Plan Startup Costs credit has strict criteria. You must have 100 or fewer employees, none of whom can be a "highly compensated employee" (like the business owner). You must have paid at least $5,000 to your employees in compensation in the previous year. You also can’t have a qualified retirement plan like a 401(k). See Form 8881 for more information.

Research Costs

Some entrepreneurs incorrectly think that incentives for research and development (R&D) are reserved only for major corporations with fancy research labs. This is absolutely false. If your business engages in research activities, you may be able to get a tax credit of up to 20% for your research expenses.

For smaller businesses, you can use this credit to offset up to $250,000 of your share of Social Security taxes. This is a tax that employees pay (it’s taken out of their paycheck), and employers match. Why would you take advantage of the Social Security option? Say you’re a freshly founded startup. You haven’t started generating revenue and don’t have a tax liability yet. In this case, a tax credit won’t do you any immediate good. However, this Social Security break can benefit you right away. See Form 6765 or Form 8974 for more information.

Family and Medical Leave Credit

U.S. law doesn’t obligate you to provide your employees with paid time off for family matters like the adoption or birth of a child. Aside from a few state tax codes, there isn’t a blanket requirement to provide paid time off for medical purposes. However, if you choose to give your employees family and medical leave, you will benefit from a tax credit. This credit is valid through Dec. 31, 2020, although an extension is possible.

To qualify, you must offer at least two weeks’ leave and pay the employee a minimum of 50% of their usual wage during this time. The employee also must have been on your payroll for a minimum of one year. They may not earn more than $72,000 to qualify. With this credit, you can claim up to 25% of the paid leave given.

Energy Tax

Energy tax incentives can help you make business improvements at a more affordable rate. For example, if you make energy-saving improvements, like installing an energy-efficient HVAC system, or buy energy-efficient appliances, you can get tax benefits.

Energy tax incentives are offered by federal, state, and local governments. Check out the Database of State Incentives for Renewables and Efficiency (DSIRE) to see what your state’s Department of Revenue offers.

Disaster Situations

Finally, the IRS offers tax relief to businesses and individuals affected by disaster situations, such as hurricanes and wildfires. The IRS provides an up-to-date list of disasters that may qualify for tax relief, sorted on a year-by-year basis. For example, in 2020, the IRS announced tax relief initiatives for California wildfire victims, victims of Hurricane Delta in Louisiana, and victims of Tennessee tornadoes. This is just a small sampling of the full list.

COVID-19

The 2020 COVID-19 pandemic is a unique situation that has required the government to undertake tax reforms, providing relief for individual taxpayers and businesses impacted by this public health care crisis. For example, affected businesses can qualify for two new employer tax credits: a credit for family and sick leave and a credit for caring for someone with the coronavirus. Check the IRS.gov website regularly for updates on this federal tax program.

For example, say an employee is unable to work because they are caring for someone infected with COVID-19 or because they have to take care of their child because the child’s school or day care is closed, and they are unable to work. As the employer, you can choose to offer the individual paid family and sick leave. Eligible employers then receive a credit for providing this leave.

Employees and Tax Incentives

The employee retention credit allows eligible employers to gain a refundable tax credit against specified employment taxes. The credit can be up to 50% of the wages an employer has paid to employees between March 12, 2020, and Jan. 1, 2021. You can immediately access this credit by minimizing employee tax deposits that you would otherwise be required to make. You can request an advance credit using Form 7200, Advance Payment of Employer Credits Due to COVID-19.

Take Advantage of Small Business Tax Incentives

Taking the time to do your research on small business tax system incentives can help reduce tax expenditure. This means you get to keep more of your money, giving you the funds you need to maintain and grow business operations.

When tax season rolls around, having all your paperwork like invoices already organized will save you time and hassle. Skynova offers comprehensive templates and software products to help you stay on top of your financial paperwork.