Data from the US Bureau of Labor Statistics shows that about 20% of small businesses fail in the first two years and almost half fail by the end of their fifth year. There are nearly 32 million small businesses in the United States employing more than 61 million people, making the success of a business not only important to the individual business owner, but also to the means of subsistence of its employees.
Tax deductions can go a long way in helping a business survive those early chaotic years. Before revealing some of the best tax deductions for small businesses, it is important to understand the difference between a tax deduction and a tax credit. Also, depending on the type of business you have, some tax deductions may be more beneficial than others.
Knowing which ones to focus on can help your business thrive.
Wait, what’s the difference between a tax deduction and a tax credit?
The two ideas lead to similar results in different ways. A tax deduction decreases the taxable income of a business, while a tax credit reduces the amount owed by a business. Think of it this way:
- A $500 tax credit granted to a business means that it reduces its tax bill by $500.
- A tax deduction for that same business has the potential to drop the business into a lower tax bracket.
Seven small business deductions you need to know
There are many deductions available, but not all of them will apply to you and your business. Be sure to speak to a tax professional or contact your local Small Business Administration (SBA) to learn more. Then you can determine the best tax opportunities for your business.
General business tax credit
These credits are mostly industry-specific, meaning not all of them can be used by your business. They are often intended to encourage companies to conduct research or invest in cleaner technologies. General business tax credits can often be carried forward for multiple years and, in certain situations, can be carried back.
Interest on business loans
If you’re a small business owner, chances are you’ve had to take out a loan. This financial burden, however, comes with a benefit. The interest you pay on this loan is tax deductible, but you must meet certain criteria.
The loan must come from a financial institution such as a bank, not from a friend or family member. You must also show an intention to repay the loan. The amount of interest you can deduct will depend on the type of loan you have.
Credit for health insurance premiums for small employers
The small business health care tax credit is a potential boon for your business. To qualify, you must be enrolled in a small business health options program and have fewer than 25 full-time employees. The average employee salary should be around $56,000 per year or less, and you should pay at least half of the premiums for your full-time employees. If you qualify, you could receive a credit of up to 50% of these premiums.
Tax Cuts and Jobs Act (TCJA)
Passed in 2017, the Tax Cuts and Jobs Act (TCJA) is the biggest tax reform the United States has seen in decades. It changed “deductions, depreciation, expenses, tax credits, and other tax items that affect businesses,” according to the IRS. You can click this link to learn more.
Qualifying Business Income (QBI)
Small businesses are often incorporated as flow-through entities, which means that the tax burden falls on the business owner. The TCJA (mentioned above) has created a new deduction for those who earn income through flow-through entities. Eligible individuals can now deduct up to 20% of their business income.
Work Opportunity Tax Credit (WOTC)
The Work Opportunity Tax Credit (WOTC) is a federal initiative, providing opportunities for those who have historically encountered barriers when seeking employment. This group includes veterans and incarcerated veterans. Small business owners can receive up to $9,600 in credits for each new hire covered by this program.
New Markets Tax Credit
The New Markets Tax Credit encourages small businesses to open in low-income communities. These communities gain jobs and access to goods/services, while small business owners receive a tax credit that applies to their federal income tax.
[This article originally appeared on the Simple Dollar in September, 2020. It was updated in December, 2021.]