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When running a business, it’s critical to take the time to understand your business taxes and how to legally minimize what you owe to the IRS. A key aspect is tax credits, which can lower your tax bill and potentially give you a significant tax refund. There are many common tax credits available, with the total number available changing from year to year. It’s important to understand how these credits work so you can make the most of them.
What is a tax credit?
Tax credits are a legal way to reduce your tax liability, or rather, the amount an individual or business owes in taxes to the government. You may qualify for tax credits by participating in eligible programs or meeting specific business criteria. These credits can offer significant tax advantages as they directly reduce the amount of tax you owe dollar-for-dollar when preparing your annual tax return.
It is important not to confuse credits with deductions. Deductions and credits work differently. While credits directly reduce the amount of tax you owe, deductions reduce how much of your income is subject to being taxed. Here is an example to help you understand how they’re used in your taxes:
Let’s look at the impact of a $1,000 credit versus a $1,000 deduction on $50,000 gross income at a 24% tax rate.
The $1,000 deduction reduces the taxable income to $49,000. That $49,000 multiplied by the 24% tax rate results in a tax due of $11,760. If we use the same $50,000 and a $1,000 tax credit, the result is much different. Since there are no deductions in play in this example, the full $50,000 is taxable. Using the same 24% tax rate results in a tax due before credits of $12,000. We then apply the $1,000 tax credit, dollar-for-dollar, to the balance due. We end up with a final tax payment due of $11,000. The dollar-for-dollar impact of the credit against the tax due results in an additional tax benefit of $760 over the deduction in this example.
So, to summarize, tax deductions lower your taxable income based on your tax bracket, while tax credits reduce your final tax due on a dollar-for-dollar basis.
Here’s a list of some of the most common business tax credits from the IRS.
The difference between business and personal tax credits
Business and personal tax credits work differently depending on the type of business you own.
If you run a business that operates as a C corporation, the corporation must file its own tax returns and use any business tax credits available to the company. However, a C corporation isn’t ideal for many small businesses for taxes, so this applies primarily to larger corporations.
If you own a business that operates as a pass-through entity, where the business’s taxes are included in calculations on one’s personal tax return, the tax credits ultimately save you money on your annual tax filing. If you run a sole proprietorship, LLC, LLC taxed as an S corporation, a partnership, or an S Corporation, you likely run as a pass-through entity.
Refundable versus nonrefundable tax credits
Tax credits fall into two main categories: refundable and nonrefundable. Understanding the difference could help you prioritize your tax planning and preparation efforts.
- Refundable tax credits: These might reduce your tax liability below zero, potentially resulting in a refund. If the credit amount exceeds your tax liability, you receive the difference as a refund.
- Nonrefundable tax credits: These might only reduce your tax liability to zero. Any excess credit amount is typically lost, although some credits allow you to carry forward unused amounts to future tax years.
Here are some examples of both business and personal tax credits and their refundability:
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Refundable Tax Credits |
Nonrefundable Tax Credits |
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Personal Credits |
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Business Credits |
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Note that not all credits are refundable in all situations. When in doubt, consult with a trusted tax expert, such as a certified public accountant (CPA).
Making the most of tax credits
Business tax credits have the potential to reduce a company’s tax liability, providing significant financial benefits and freeing up capital for growth. These credits often incentivize specific investments or behaviors, aligning business interests with broader economic and social goals. Generally speaking, credits provide more substantial savings than deductions, making them valuable tools for cost management.
Whatever type of business you own, it’s worthwhile to spend the time to understand what tax credits you may qualify for to get the best financial results.
