Listen to this article 5 min
The Covid-19 pandemic and the rescue programs that came with it have driven a surge of interest in tax credits, with small-business owners increasingly scouring for opportunities they may have overlooked in the past.
The Small Business Administration’s Paycheck Protection Program, which gave out 11.3 million forgivable loans worth about $786 billion, as well as the Economic Injury Disaster Loan program and others, made it to clear to small-business owners they should pay attention to government programs and apply for the ones that fit them, said Brent Johnson, co-founder of Clarus Solutions, which helps businesses access federal employment tax credit programs.
“Covid really changed participation in tax incentives in a really meaningful way. Large corporate taxpayers would participate and smaller businesses participated at a far reduced rate. But smaller businesses became much more aware of tax credits and the impact they could have on their business and they are looking at them more than they have in the past — and that's a good thing,” Johnson said in an interview with The Playbook.
Interest could surge even more as economic headwinds result in tighter margins and leave businesses looking to cut expenses or capitalize on tax credits.
Experts say small-business owners can more easily understand the tax credit landscape once they realize the federal government is largely interested in three categories of business spending: employment and hiring, research and innovation and larger capital expenditures. If a business is doing any one of those things, they should be on the lookout for potential tax credits, Johnson said.
He highlighted several potential tax credits for businesses to keep in mind, including:
The Work Opportunity Tax Credit
The Work Opportunity Tax Credit is for businesses that hire a wide variety of disadvantaged groups, including previously incarcerated individuals, people with disabilities, veterans and residents of specific low-income communities, among others. The tax credit could be particularly useful now as employers grapple with labor challenges. Experts say one key is to look for talent in unconventional places.
The credit is equal to 40% of up to $6,000 in wages paid to a person in one of the qualifying groups in their first year of employment who works at least 400 hours for the business. That means the maximum total credit is about $2,400 and counts toward the business’ income tax liability.
The credit began in 1996 when it replaced a previous and similar credit, Johnson said. The tax credit has attempted to help the long-standing issue of making it easier for employers to hire people who might struggle in their first few weeks or months on the job.
“It's an incentive that is out there to encourage employers to hire people that have some barrier to entry to the workforce,” Johnson said. “And it encourages employers to keep these folks.”
Federal Insurance Contributions Act, or FICA, Tip Credit
The FICA Tip Credit allows an eligible business to claim a credit against its income taxes for FICA taxes paid on tipped wages exceeding the minimum wage.
An analysis by the IRS in 2016 found that most of the FICA tip credits went to larger businesses.
Proponents say it encourages employers to report tip income, which improves overall tax compliance and ensures future Social Security benefits for tipped workers. But opponents say the tip credit has not done that and is unfair because it is not available to other workers beyond the food and beverage service sectors.
"Some restaurants claim it and some don’t, surprisingly," Johnson said. "It's probably a lack of awareness and understanding that it's available to them."
The Employee Retention Credit
Initially, the ERC was a quarterly, refundable tax credit based on wages for business owners to retain staff during the Covid-19 pandemic. It was set at 50% of up to $10,000 in qualifying wages per employee for the last three quarters of 2020. The American Rescue Plan Act extended and expanded the ERC to include up to 70% of $10,000 in qualifying wages per employee per quarter in 2021 for the first three quarters, making it much more lucrative to business owners.
To qualify, businesses needed to record a drop in revenue during 2020 and or the first three quarters 2021 compared to 2019, or — and it's a big or — they had to be operating under significant government restrictions, which includes many restaurants, daycares and other businesses. Companies that qualify in all available quarters could receive up to $26,000 per full-time employee over the entire credit — although that's not common.
Businesses that took the SBA’s Paycheck Protection Program also still qualify, with their PPP amount being deducted from what they would get from the credit, which is still a significant amount for many businesses owners.
"Small businesses have to assess whether they are eligible or not," Johnson said. "The economics are so significant if they are eligible they just have to. It's too much money to leave to chance."
The program has become popular enough that the Internal Revenue Service, is warning business owners to scrutinize solicitations involving the ERC. Johnson said there are some quick and easy rules to follow to help protect your small business from operators who might not be able to deliver the tax credit in a responsible way. That includes asking to make sure you get the ERC justification in writing, that they have the appropriate insurance if something goes wrong and that they have a history of working with businesses on tax credits.
Meanwhile, the IRS received a boost in funding to add more enforcement agents, and Johnson said the ERC remains a compelling target.
"One has to believe that they're going to be focused on this for the next several years," Johnson said, adding there is a five-year window in which the IRS can take a look at ERC claims. But he stressed that time will start to run out on claiming the full credit. "You’ve got another six months before the statute of limitations starts to fall off on employee retention claims. You have to address it. It's too much money to leave on the table."
Electric vehicle tax credits for businesses
The Inflation Reduction Act includes a tax credit for qualifying electric vehicles of up to $7,500 for vehicles weighing less than 14,000 pounds, and up to $40,000 for vehicles that weigh more than that, subject to certain limitations.
The credit is slated to last until the end of 2032, according to the legislation.
The buildout of electric charging stations could also mean a tax credit of $30,000 to $100,000, Fowler said, with the credit to be calculated based on a single unit rather than per location.
Research and development tax credits
The Inflation Reduction Act also doubled the research and development tax credit from $250,000 to $500,000. The tax credit is refundable and applied against payroll taxes and includes expenditures for a wide variety of expenses, including the improvement or development of products, processes, techniques or even software.
Johnson said small-business owners need to be proactive about these tax credits and any others they might be eligible for.
Sometimes the tax credits are easy to find — such as when shopping for a new electric vehicle, Johnson said. In that case the dealership should be able to walk people through potential credits or incentives.
“Tax credits are really fundamentally part of an overall tax plan,” Johnson said. “This is a component that a lot of business owners miss, but now that they have seen the dollars from the Covid programs they need to think about the other categories.”
