For small to mid-sized businesses, every dollar counts, and taking advantage of tax credits can provide significant financial relief by allowing businesses to use the funds to reinvest in growth, development, and benefits for their people.
For HR and payroll professionals, understanding and optimizing tax credits for small businesses is crucial and can be time-consuming to fully grasp. This blog breaks down what tax credits are and offers practical strategies on how to maximize these opportunities. Please keep in mind that this blog is not meant to provide tax or financial advice, and companies should always consult with their financial and tax advisors before making any changes to the structure of their organizations and tax filings.
Understanding tax credits for small businesses
Tax credits are amounts of qualified money that businesses can subtract from the amount of tax they owe the government. This directly reduces the amount of taxes, dollar-for-dollar, making these credits incredibly valuable for smaller businesses looking to minimize expenses and reinvest dollars back into their companies.
What’s the difference between tax credits and tax deductions?
While both tax credits and tax deductions can reduce a business's taxes, they work in different ways. As noted previously, tax deductions lower the amount of income subject to tax, while tax credits directly reduce the tax owed. For example, a $10,000 tax deduction might save a business $2,000 in taxes (assuming a 20% tax rate), whereas a $10,000 tax credit would save the business the full $10,000.
Types of tax credits (refundable vs. non-refundable)
There are two main types of tax credits — refundable and non-refundable. Refundable tax credits can reduce a business's tax liability below zero, which results in receiving a refund. Non-refundable tax credits, however, can only reduce the tax liability to zero, and any additional credits are carried forward to future tax years.
Key tax credits for small businesses
The Work Opportunity Tax Credit (WOTC)
According to the IRS, the Work Opportunity Tax Credit (WOTC) is designed to incentivize businesses to hire individuals from specific target groups who face significant barriers to employment, which is meant to drive workplace diversity and help ensure everyone has access to quality jobs.
Eligibility criteria
An employer may claim the WOTC if they employ someone who is certified as a member of any of the following targeted groups according to the IRS:
- Those who were formerly incarcerated or previously convicted of a felony
- The recipients of state assistance under part A of title IV of the Social Security Act (SSA)
- Veterans
- Residents in areas designated as empowerment zones or rural renewal counties
- Individuals referred to an employer following completion of a rehabilitation plan or program
- Individuals whose families are recipients of supplemental nutrition assistance under the Food and Nutrition Act of 2008
- Recipients of supplemental security income benefits under title XVI of the SSA
- Individuals whose families are recipients of state assistance under part A of title IV of the SSA
- Individuals experiencing long-term unemployment
Application process
To qualify for the WOTC, businesses must first pre-screen and obtain certification from the appropriate Designated Local Agency, also known as a State Workforce Agency, to confirm that an employee is a member and eligible to claim this credit.
To obtain this certification, either on the day the job offer is made or before, both the employee and the employer must fill out a pre-screen notice called Form 8850. This form requires the dates when the information was given, when the offer was made, when the offer was accepted, and when the job was started. The credit amount varies based on the employee's target group and hours worked. If a certification is not received on or before the new employee’s first day, the employer must request certification by submitting Form 8850 to the State Workforce Agency of the state where the employee works within 28 days of when they begin work.
The Small Business Health Care Tax Credit
The Small Business Health Care Tax Credit is designed to help small businesses afford the cost of providing health insurance to their employees. This credit is particularly beneficial for small businesses because it can cover up to 50% of the premiums and the amount of credit received is on a sliding scale — the smaller the company, the higher the credit.
The maximum credit is typically a percentage of premiums paid during the tax year for certain health insurance coverage provided to employees enrolled in a qualified health plan offered through a Small Business Health Options Program (SHOP) Marketplace.
Requirements and benefits
According to the IRS, the Small Business Health Care Tax Credit benefits employers that:
- Have fewer than 25 full-time equivalent employees
- Pay average wages of less than $50,000 a year per full-time equivalent (indexed annually for inflation beginning in 2014)
- Offer a qualified health plan to its employees through a Small Business Health Options Program Marketplace (or qualify for a limited exception to this requirement)
- Pay at least 50% of the cost of employee-only – not family or dependent – health care coverage for each employee
How to claim
Businesses can claim the credit by filing IRS Form 8941 with their annual tax return. It's important to keep detailed records of premium payments and employee information to support the claim.
Family and Medical Leave Act (FMLA) tax credit
The FMLA Tax Credit is meant to encourage businesses to provide their people with paid family and medical leave. By having a written policy that offers at least two weeks of paid leave at a rate of at least 50% of an employee's regular wages annually, employers can take advantage of this tax credit.
Eligibility and benefits
To be eligible, businesses must have a written policy in place that meets the FMLA requirements mentioned above. Employees must qualify under the Fair Labor Standards Act, have been employed by the company for more than a year, and had compensation under a certain amount. The leave itself, according to the IRS, must be for one of the following reasons and must not qualify for any paid time-off policies the organization may have in place.
- Birth of an employee's child and to care for the child
- Adoption or foster care
- To care for the employee's spouse, child, or parent who has a serious health condition
- A serious health condition that makes the employee unable to perform the functions of their position
- Any qualifying exigency due to an employee's spouse, child, or parent being on covered active duty (or having been notified of an impending call or order to covered active duty) in the armed forces
- To care for a service member who is the employee's spouse, child, parent, or next of kin
How to claim
In order to claim this tax credit, businesses must file IRS Form 8994 with their annual tax return. Detailed records of leave policies and payments are essential for substantiating the claim. This tax credit was due to end in 2019; however, it was extended to 2025.
Strategies for maximizing tax credits
Keep accurate records and documentation
As with anything tax-related, keeping track of important documents is key to being able to take advantage of tax credits seamlessly and accurately. By maintaining detailed documentation and using technology that can help guide you on which records to keep and for how long, companies can ensure that they are able to substantiate their claims. Additionally, by using technology that offers this guidance, companies can avoid potential audits or costly penalties for inaccurate information.
Examples of key documents include employee eligibility forms, payroll records, health insurance premium payments, and written leave policies. Maintaining organized and up-to-date records for all your people simplifies the application process and ensures compliance.
Ensure compliance along the way
By conducting regular audits and compliance checks, companies can ensure that all documentation is accurate and up to date before tax documents are due. This proactive approach can prevent issues during tax filing and maximize credit claims.
Additionally, tax laws are constantly evolving — a perfect example is the extension of the FLMA Tax Credit mentioned previously! Staying informed on changes and new opportunities is crucial. A great way to stay on top of all the changes is by subscribing to newsletters, consulting with professionals, and implementing an HR and payroll solution designed to provide the latest compliance updates relevant to your organization.
Utilize technology
By leveraging an all-in-one HR and payroll solution, companies can enjoy the automation of many aspects of compliance tracking. From being able to identify opportunities and eligible employees to generating necessary forms, technology can help you maximize the opportunity to take advantage of tax credits while saving time and reducing errors.
Conclusion
Tax credits offer significant financial opportunities for small businesses, and by capitalizing on these opportunities, companies can use those funds to grow the company and invest in their people. If you’re ready to explore an all-in-one HR and payroll solution to help you understand the various credits available, maintain the right records, and stay on top of tax changes so you can maximize your company’s tax savings, see why UKG Ready® may be the right solution to help you keep up with compliance.
