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Tax Credits Commonly Available to Small Businesses

Filed under Federal Taxes. Fact checked on November 19, 2014.

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Credits for providing health insurance, starting a retirement plan, providing child-care, improving access for the disabled, or providing work to disadvantaged individuals are among the credits that many small business owners may wish to explore.

While it's true that many tax credits are highly targeted and available (for all practical purposes) only to very large businesses, there are some that a small business should utilize particularly if they have employees.

Among the credits that all small business employers should evaluate are the following:

  • Small Business Health Care Credit
  • Retirement Plan Startup Credit
  • Disabled Access Credit
  • Business Energy Credit

Claim Your Small Business Health Care Credit

If you employ fewer than 25 full-time equivalent employees and pay at least half of the premiums for single health insurance coverage for their employees are eligible to claim a tax credit. This credit is specifically targeted to help small businesses and tax-exempt organizations that primarily employ moderate- and lower-income workers.

Warning

Beginning in 2014, this credit is only available if you pay premiums for employees who enrolled in a qualified health plan offered through a Small Business Health Options Program (SHOP). You can no longer claim the credit for insurance provided outside of this program.

The small business health care tax credit is designed to encourage both small businesses and small tax-exempt organizations to offer health insurance coverage to their employees for the first time or to maintain coverage they already have.

In 2010 through 2013, the maximum credit was 35 percent of the employer's eligible premium expenses. Beginning in 2014, the maximum credit increased to 50 percent. You can only clam the credit for two consecutive years.

Claiming this credit can result in a substantial tax savings. For example, if you paid $72,000 in health care premiums for your employees, and you meet all the requirements for the full amount of the credit, then you could claim a credit for $36,000 (50% x $72,000).

Tip

Health insurance premiums paid for an employee are deductible business expenses. However, a tax credit is almost always better than a deduction because a credit cuts your tax bill dollar-for-dollar, while the value of a deduction is tied to your marginal tax bracket.

In order to maximize your tax savings, you should claim as large a tax credit as possible, and then deduct the remaining premiums.

To qualify for this credit: you must be a "qualified employer." Prior to 2014, you also had to pay the premiums under a "qualifying arrangement." The requirement was replaced with the requirement that the employees obtain their coverage under a SHOP plan.

What Is a Qualifying Employer?

To be a qualified employer, you must have fewer than 25 full-time employees (FTE), regardless of whether or not they are enrolled in your health plan, and their average annual wages must be least then $50,000 per full-time employee.

How to Calculate Number of full-time employees. To find out how many FTEs you have, add the total number of hours of service for which you paid wages to employees during the year and, then, divide this number by 2080. If the result is a fraction, it gets rounded to the nearest whole number.

To determine the number of the employees, you consider the hours of service of all employees: both full and part-time. You can determine the number of hours your employees worked by any of the following methods:

  • using records showing their actual hours of service and of paid leave;
  • using a "days-worked equivalency" which credits an 8 hours of service for each day in which the employee actually worked one hour; or
  • using "weeks-worked equivalency" which credits an employee with 40 hours of service for each week if he or she actually worked for one hour in the week.
Example

During the year, you paid five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours.

You are using the hours actually worked method to determine FTEs.

First you total the hours of all employees, not exceeding 2,080 per employee. This means that you only count 2,080 of the 2,300 hours worked by one employee. The total number of hours is 15,600 hours ((6 x 2,080)+(3 x 1,040).) This total is divided by 2,080, which equals 7.5. A fraction is rounded to the nearest whole number, in this case, 7.

This is tax law--so, of course, there are some caveats.

You can't count more than 2080 hours for an employee. Also, you aren't required to count more than 160 hours of service for any single continuous period of paid leave. Seasonal workers are disregarded in determining FTEs and average annual wages unless the seasonal worker works for the employer on more than 120 days during the tax year, although premiums paid on their behalf may be counted in determining the amount of credit.

Owners and family members are not employees. In addition, you probably will not be able to count yourself or your family members for any purpose related to the Health Care Tax Credit. You are not considered an employee--for purposes of this particular credit if you are:

  • a sole proprietor,
  • a partner in a partnership,
  • a shareholder owning more than two percent of an S corporation, or
  • any owner of more than five percent of of the business (e.g., an LLC member).

Thus, your wages or hours are not counted in determining either the number of FTEs or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit.

Similarly, the family member or member of the household of the business owners or partners is not considered an employee for purposes of the credit. Thus, neither their wages nor their hours are counted in determining the number of FTEs or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit.

For this purpose, a family member is defined as:

  • a child (or descendant of a child);
  • a sibling or step-sibling;
  • a parent (or ancestor of a parent);
  • a step-parent;
  • a niece or nephew;
  • an aunt or uncle;
  • or a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.
Warning

Even if you qualify, the amount of your credit may be reduced if you have more than 10 full-time employees and/or the employees' average annual wages exceed $25,000. (See Limits on the Amount of Credit, below.)

How to determine average wages. You determine the amount of average annual wages by dividing (1) the total wages you paid during the year to employees whose hours are included in the FTE computation by (2) the number of your FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). Wages for this purpose means wages as defined for FICA purposes (without regard to the wage base limitation.)

Be Aware of Limits on Amount

Even if you are a qualifying employer and you pay premiums under a qualifying arrangement, the amount of the credit you can claim may be limited by three factors:

  • the "average premium for the small market group" in your state;
  • the number of employees and their average annual wages; and
  • the amount of your taxable income.

State Average Premium Cap Limits Health Care Credit Amount

The amount of premium payments that can be counted toward the credit is limited to the smaller of:

  1. the "average premium for the small group market in the state (or area of the state)" for comparable insurance coverage or
  2. the amount you actually paid for the premiums through the SHOP plan.

The average premium for the small group market in a state (or an area within the state) is determined by the Department of Health and Human Services (HHS). The amounts are listed in the instructions for Form 8941 Credit for Small Employer Health Insurance Premiums.

This is a cap on the total amount. For purposes of this test, you can aggregate all your costs under all your qualifying plans.

Number of Employees, Average Salary May Limit Credit

Once you have determined the total amount of eligible premium costs, you may have to reduce that amount if you have more than 10 employees and/or the average wage is more than $25,000. Beginning in 2014, this base amount is indexed for inflation, so it is essential to consult the filing instructions for Form 8941 to determine the current amount.

If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10 and the denominator of which is 15. If average annual wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual wages exceed $25,000 and the denominator of which is $25,000.

For an employer with both more than 10 FTEs and average annual wages exceeding $25,000, the reduction is the sum of the amount of the two reductions.

Note that this sum may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual wages of less than $50,000

Example

You have 12 FTEs and average annual wages of $30,000. You paid $96,000 in health care premiums for those employees, which does not exceed the average premium for the small group market in your state, and otherwise meets the requirements for the credit.

The credit is calculated as follows (using the unindexed wage amount):

  • Initial amount of credit determined before any reduction: (50% x $96,000) = $48,000)

  • Credit reduction for FTEs in excess of 10: ($33,600 x 2/15) = $4,480

  • Credit reduction for average annual wages in excess of $25,000: ($33,600 x $5,000/$25,000) = $6,720

  • Total credit reduction: ($4,480 + $6,720) = $11,200

  • Total tax credit: ($48,000 - $11,200) = $36,800.

The amount that cannot be claimed as a credit may be claimed as a business expense deduction.

Amount of Taxable Income May Limit Credit

The amount of credit can only offset your actual income tax liability or AMT liability for the year, unless you are a tax-exempt employer. However, any unused credit amount can generally be carried back one year and carried forward 20 years.

Special Rules Apply to Tax-Exempt Employers 

A tax-exempt employer is eligible for the credit. A tax-exempt without taxable income can receive the credit as a refund--up to the amount of the tax-exempt's income tax withholding and Medicare tax liability. The maximum credit amount is 35 percent. To claim the credit, the organization must file a Form 990-T, Exempt Organization Business Income Tax Return, even if you would not need to otherwise.

Use Form 8941 to Claim the Credit

If you qualify for the credit, and you are not a tax-exempt employer, you claim the credit using Form 8941, which must be attached to your income tax return.

Claim a Credit To Offset Cost of Establishing Retirement Plan

To stimulate greater retirement saving, small employers who establish new retirement plans are now entitled to a tax credit for doing so.

The credit is only available to employers

  • who do not have more than 100 employees and
  • who have not maintained a qualified retirement plan during the three-year period immediately before the first effective year of the new plan.

The credit amounts to 50 percent of the costs incurred in creating or maintaining a new qualified plan, up to a maximum of $500 in each of the first three years the plan is effective. Essentially, this means that you have to spend at least $1,000 per year to get the full credit.

Any set-up and administration costs not offset by the tax credit (i.e. those above $1,000 in the first three years and those incurred after the first three years) are deductible as ordinary and necessary business expenses.

Tax Break Available for Making Your Business Accessible

Under the Americans with Disabilities Act of 1990 (ADA), businesses that are open to the public ("public accommodations" in legal language) must accommodate or help persons with disabilities seeking to use their services.

This means that businesses must also remove physical barriers to the disabled, if removal is "readily achievable." For example, the regulations say that moving tables in a restaurant is "readily achievable," but widening a doorway is not. What's more, any renovations or new construction must include provisions for accessibility by the disabled, in accordance with certain very technical specifications.

Small businesses that are faced with making changes to obey the ADA have been given a "carrot," in the form of a tax credit, to encourage them to comply with the law.

What Businesses Are Eligible?

For purposes of this credit, a small business is one that meets either of these tests:

  • the business has gross receipts of $1 million or less, or
  • the business has no more than 30 full-time employees.

In addition, this tax credit is available only to small businesses that furnish public accommodations. However, nearly every business that sells, gives or offers any type of product or service to the public is likely to be considered a "public accommodation."

The law specifically mentions 12 types of businesses, but notes that it not intended to be an exhaustive listing. The 12 specifically listed business categories are

  1. places of lodging, such as inns, hotels, and motels, except places where the proprietor resides and rents out no more than five rooms;
  2. establishments serving food and drink, such as restaurants and bars;
  3. places of exhibition or entertainment, such as theaters, concert halls, and cinemas;
  4. places of public gathering, such as auditoriums, convention centers, and lecture halls;
  5. sales or rental establishments, such as stores and shopping centers;
  6. service establishments, such as dry cleaners, banks, beauty shops, and offices of doctors, lawyers, and other professionals;
  7. public transportation stations;
  8. places of public display, such as museums, libraries, and galleries;
  9. places of recreation, such as parks, zoos, or amusement parks;
  10. places of education, such as private schools including nursery schools;
  11. social service centers, and
  12. places of recreation such as gyms, health spas, bowling alleys, or golf courses.

What Expenses Qualify? 

For any year, the tax laws allow you to claim a credit for 50 percent of your eligible access expenditures that exceed $250 but don't exceed $10,250. So, you can't claim more than $5,000 in any one year.

The "eligible access expenditures" include not only expenses for removal of physical barriers (in renovations, but not new construction), but also expenses for deaf interpreters; readers for the blind; equipment or devices to make services available to the deaf, blind, or other disabled persons; or similar expenses.

Think Ahead

If you anticipate that your disabled accommodation expenses will exceed $10,250, try to spread them over more than one year in order to take maximum advantage of the tax credit.

Claim Disabled Access Credit on Form 8826

The disabled access credit is claimed on Form 8826,Disabled Access Credit, and is part of the general business credit. In addition to the dollar limit mentioned above, the total of all your general business credits can't reduce your current year's tax bill below the larger of (a) your tentative minimum tax or (b) 25 percent of the part of your regular tax bill that exceeds $25,000.

Save Energy and Taxes with Alternative Energy Sources

An energy credit is allowed for 10 percent of the cost of the following types of business property placed in service during the year:

  • equipment that uses solar energy to generate electricity, heat or cool a structure, provide hot water, or provide solar process heat; or
  • equipment used to produce, distribute, or use geothermal energy stored in rocks, water, or steam.

The property must be depreciable and it must be used in your business.

The energy credit is part of the investment tax credit, and must be recaptured (paid back to the IRS) if the qualifying property is sold or disposed of before the end of its recovery period. It is claimed on Form 3468, Investment Tax Credit.

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