What Are Tax Credits?
By Attorney Stephen Fishman
Obtaining a tax credit is the next best thing to paying no taxes at all. A tax credit is a sum of money that you directly deduct from your taxes—for example, a $1,000 tax credit reduces the amount of taxes you pay by $1,000. This is much better than a $1,000 tax deduction, which only reduces your taxable income. If you’re in the 28% income tax bracket, a $1,000 tax deduction will save you only $280 in taxes (28% x $1,000 = $280). A person in the 28% tax bracket would need $3,571 in tax deductions to save $1,000 in income taxes.
Credits versus Deductions
Tax credits are subtracted directly from your tax liability. Credits reduce tax liability dollar-for-dollar.
$1,000 credit = $1,000 tax reduction.
Tax deductions are subtracted from your total income to compute your taxable income. Deductions reduce tax liability by the amount of the deduction times the tax rate.
$1,000 deduction x 28% tax rate = $280 tax reduction.
To get a business credit, your business must do, or be involved in, something that Congress likes or views as socially beneficial. There are many different types of tax credits for businesses. However, many business credits are quite specialized and can be used only by specific types of businesses. Some of the better known tax credits for businesses include:
Alternative motor vehicle credit. This includes a number of credit s for business use of alternative fuel vehicles, including electronic and hybrid vehicles. consists of the following credits for certain vehicles you placed in service.
Credit for employer Social Security and Medicare taxes paid on employee tips. This credit is intended to reimburse owners of food and beverage businesses for the employer’s portion of Social Security and Medicare taxes paid on employees tips.
Credit for employers with employees on active duty. This credit gives small businesses financial incentive to continue to pay wages to an on active duty in the armed forces.
Credit for employer-provided childcare. This credit applies to expenses you pay for employee childcare and childcare resource and referral services. The credit is 25% of qualified expenses you paid for employee childcare and 10% of qualified expenses you paid for childcare resource and referral services
Credit for increasing research activities. The research and experimentation credit, also called the R & E credit, is intended to encourage businesses to invest in scientific research and experimental activities, including energy research. Any technological research qualifies, so long as it relates to a new or improved function, performance, reliability, or quality. The research must involve principles of the physical or biological sciences, engineering, or computer science.
Credit for small employer health insurance premiums. This new credit helps small businesses afford the cost of covering their employees and is targeted for those with low-and moderate-income workers. The credit is designed to encourage small employers to offer health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees.
Credit for small employer pension plan startup costs. This credit reimburses employer’s for pension plan startup costs.
Disabled access credit. This credit is for small businesses that incur expenses to comply with the Americans with Disabilities Act of 1990.
Low-income housing credit. This credit generally is for builders and developers who build low-income housing.
New hire retention credit . This credit may apply if you hired an employee after February 3, 2010, and before January 1, 2011, and the employee works for you for at least 52 consecutive weeks.
Work opportunity credit. This is a credit paid to employers who hire employees from targeted groups that have a particularly high unemployment rate or other special employment needs—for example, welfare and food stamp recipients, low income ex-felons, disabled people, and high-risk young people. You can also get a credit for giving disadvantaged youths summer jobs.
Empowerment Zone Employment Credit. This is a credit for businesses that hire employees to work in federal “empowerment zones”—areas designated as economically disadvantaged.