As an employer, business tax credits can be a great way to not only strengthen your bottom line but also create a more diverse workforce, increase employee satisfaction, and protect the planet. Business tax credits are incentives offered by the government to encourage certain types of behaviors and actions, such as hiring, investing in research, or going green. By claiming business tax credits, organizations can reduce the amount of taxes they owe each year, making them an invaluable resource for improving the finances of a business.
To help you understand which business tax credit to claim, we’ve created this in-depth guide on tax credits for businesses. From understanding their benefits to learning about how to calculate your incentive, you’ll learn about which credits to claim and how.
Understanding Tax Credits and How They Benefit Your Business
Tax credits are incentives offered by the government to reduce a business’s tax liability so long as the business engages in certain activities that align with policy goals, whether hiring employees from underrepresented groups or providing family or medical leave to employees. Unlike tax deductions, which reduce the amount of business income that’s subject to tax, tax credits directly lower the amount of taxes owed. There are several ways tax credits can benefit your business, such as:
- Reduce tax liability: The most prominent benefit of tax credits is that they reduce your organization’s tax liability for the year they’re claimed, which can save your business significant amounts of money.
- Improve cash flow: With more money due to a lighter tax burden, companies can use those savings for reinvestment or operational needs to enhance their cash flow.
- Promote growth: Many tax credits are aimed to help businesses grow, like the Work Opportunity Tax Credit (WOTC) that incentivizes organizations to expand their workforce by hiring employees from underrepresented target groups.
- Encourage social responsibility: Other business tax credits, such as the Family Leave Act Tax Credit, encourage businesses to remain socially responsible by partaking in actions like offering family and medical leave to employees.
Rules and Requirements
Because business tax credits help employers reduce their tax liability for the year, the IRS has strict regulations in place and conducts regular audits to ensure employers are applying for these credits in good faith and meeting the necessary eligibility criteria. Each tax credit incentive has its own defined eligibility criteria written in the tax code, meaning compliance is paramount to avoid the potential of penalties and fees. However, these regulations often deter employers from applying for tax credits in the first place, as they may fear they won’t qualify for the program they may be interested in.
For example, training grants are often given to organizations to support employers who need to improve the skills and capabilities of their workforce through specialized training. They are also offered to help organizations with skill shortages or high unemployment. However, to qualify for training grants and tax incentives, businesses are often required to be in specific industries, such as healthcare or manufacturing, as well as train their employees in a specific way. In many cases, employers may fail to adhere to the strict training requirements, deeming them ineligible
To qualify, it’s crucial for employers to obtain as much information as possible from other companies going through the process and tax professionals who have a deep understanding of the tax code and eligibility requirements. Advisors with experience in certain tax incentive programs can provide the insights and knowledge needed to ensure compliance when claiming a specific tax credit
WOTC
What is the WOTC? The Work Opportunity Tax Credit (WOTC) is a federal tax credit designed to encourage employers to hire individuals from specific target groups who have historically faced significant barriers to employment. Any employer can claim the WOTC if they meet the eligibility criteria for hiring workers from the following target groups:
- Qualified IV-A recipient
- Qualified veteran
- Qualified ex-felon
- Designated community resident (DCR)
- Vocational rehabilitation referral
- Qualified summer youth employee
- Qualified Supplemental Nutrition Assistance Program (SNAP) benefits recipient
- Qualified Supplemental Security Income (SSI) recipient
- Long-term family assistance recipient
- Qualified long-term unemployment recipient
Additionally, in order to be eligible, the individual hired from one of these target groups must be in their first year of employment and perform at least 400 hours of qualified work for their employer. Once these eligibility criteria are met, the WOTC is equal to 40% of up to $6,000 of wages paid to that individual.
To ensure a new hire is from a target group, employers must conduct a pre-screening using Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Tax Credit, which they and the new hire must complete before or on the same day a job offer is extended.
Disaster Zone Tax Credit
There are several Disaster Zone Tax Credits that can help businesses recoup some of the losses incurred from qualifying disasters, such as hurricanes, fires, floods, and other events that render their business inoperable. A popular Disaster Zone Tax Credit is the Employee Retention Credit, which is available to businesses that continue to employ workers despite being unable to operate due to a federally declared disaster.
Additionally, many states have state-level tax credits that can help employers get back on their feet after a qualifying disaster. For example, New York State has the New Markets Tax Credit Program (NMTC Program), which offers a tax credit to businesses that foster job creation in low-income communities in the state. One way businesses may be able to qualify for this tax credit is if they make investments that foster job creation and community development in federally declared disaster zones by the Federal Emergency Management Agency (FEMA).
Family Leave Act Tax Credit
Small business tax credits like the Family Leave Act Tax Credit, sometimes referred to as the Employer Credit for Paid Family and Medical Leave, offer incentives to employers who offer paid family and medical leave to employees. Introduced by the Tax Cuts and Jobs Act of 2017, this business tax credit encourages employers to provide paid leave to families or those needing medical leave.
Any employer who provides at least two weeks of paid family and medical leave to full-time employees may be eligible for this tax credit. If eligible, the Family Leave Act Tax Credit can range from 12.5% to 25% of wages paid to employees on family or medical leave, depending on the percentage of wages that were replaced while on leave. Examples of qualified family or medical leave include the birth of a child or care for a child, an employee experiencing a health condition that makes them unable to perform their job duties, or an employee caring for a service member who is their spouse, child, parent, or next of kin
Accurately Calculating Your Credit and Incentive
Knowing how to calculate your credit is critical to determining your eligibility for a tax credit. There are several numbers on your payroll needed for an accurate calculation, such as wage base or overtime pay.
- One/Zero Analysis: A popular method used for calculating many tax credits is the One/Zero Analysis, which looks at the number of eligible employees and the months each employee worked. For many business tax credits, it’s all or nothing. For example, one tax credit may only tally full-time workers who work 35 hours per week toward the eligibility criteria of that credit, meaning an employee working 34.99 hours is not taken into account. With today’s remote work trends, it can be challenging for employers to meet the required hour and wage requirements for tax credits.
- Eligible weeks worked: Many tax credits look at eligible weeks worked. Understanding how these work weeks are calculated is essential, as some employees may work for several weeks at a time and then have several weeks off, for example. In cases like these, the eligible weeks worked in a single year can become diluted and cause miscalculations.
- Eligible pay: Tax credits also often require employees to earn a certain amount in wages. However, certain payment structures, such as those involving commissions, can cause fluctuating pay cycles. For instance, in one pay period, an employee may meet the eligible pay requirement while failing to meet this requirement the following pay period. Understanding these nuances can help ensure accurate calculations.
Streamlining Hiring and Tax Credit Capture
Optimizing the hiring process can help businesses efficiently capture all the tax credits available to them. Many employers are eligible for multiple tax credits, such as the WOTC and Family Leave Act Tax Credit, and streamlining the hiring process can ensure businesses don’t miss out on these valuable incentives. For example, implementing applicant tracking systems with pre-screening questionnaires can filter candidates who may qualify for tax credits. At the same time, a simplified onboarding process can help gather all the necessary documentation landforms, such as IRS Form 8850, for pre-screening for the WOTC.
How Experian Employer Services Can Streamline the Process
At Experian Employer Services, our tax credit management services help employers of all sizes capture all eligible tax credits while maintaining compliance throughout the process. With our solutions, you can maximize your possible return while bolstering your bottom line. Book a demo today to learn more about our workforce management solutions.