Using Tax Credits As Revenue for Your Business
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Starting a business can be overwhelming. There’s filing for licenses and permits; figuring out how to classify both the business and employees; writing a business plan and more. It’s enough to make an entrepreneur’s head spin. What does the new generation of business owners need to know about starting a business?
Who should manage my startup’s finances?
For startup and small business founders alike, there are many issues to consider; managing finances is usually top of mind. However, consider managing your startup’s finances in-house rather than hiring an outside CPA.
Why? It’s nearly impossible for a third-party CPA to understand enough about your startup to benefit your company financially. After all, there are more than 2,500 tax credits available on the federal, state, county, and local levels, and it’s difficult to identify them all.
Startup business owners should identify opportunities to extend their runway and support their core product development in a time when seeking outside funding may seem more uncertain.
[Editorial comment – Smart Hustle believes that for very small companies they might not need a CPA. However, for growing companies, a CPA (accountant) can be an important professional to not only do your taxes but give you tax advice and help you understand your cash flow and over financial management]
Identifying revenue opportunities through tax credits
The U.S. government wants to inspire startups and small businesses to grow, develop, and strengthen our economy by issuing tax credits. However, less than two percent of those businesses take advantage of these government tax credits. As such, they leave hundreds of billions of dollars on the table.
Tax deductions lower the amount of taxes a business owner must pay to the government. Tax credits, which lower the dollar amount of payroll or other taxes owed, are also available and may prove more valuable to small business owners and startup founders. There are hundreds of these federal, state, and local incentives.
Why do tax credits go under-utilized? They can be confusing and difficult to claim. The sheer volume alone is often daunting for small business owners. This can cause companies to miss out on funding opportunities.
Since many startups are not profitable, certain tax incentives may be unavailable to them. However, there are several opportunities to add to a revenue stream before the company begins to turn a profit.
R&D Tax Credit
Research & Development (R&D) tax credits are available to any qualified business working on new, improved, or technologically advanced products or processes. The R&D tax credit is designed for new businesses seeking to bring new products to market in almost any industry. It is available to most startups in the U.S.
There are more than 50 R&D tax credit programs across the country and ample opportunity for a business to recoup some of the money spent on research and development. In fact, small businesses can see a six to 14 percent return. This could potentially add up to hundreds of thousands of dollars annually.
On average, businesses can save as much as $51,040, or between $3,000 and $6,000 per employee on payroll.
Work Opportunity Tax Credit
Companies that pay employees designated by a state workforce agency as people who have experienced “barriers to employment,” for example, are eligible for the Work Opportunity Tax Credit (WOTC). These groups include but are not limited to:
- Veterans
- ex-felons
- summer youth employees
- individuals who have been unemployed long-term
- Supplemental Security Income (SSI) Recipients
According to the IRS, “the WOTC is equal to 40% of up to $6,000 of wages paid to, or incurred on behalf of, an individual who is in their first year of employment; is certified as being a member of a targeted group; and performs at least 400 hours of services for that employer.”
Retirement Plans Startup Tax Credits
An employer that offers retirement plans, like a 401(k) or SIMPLE IRA, to its employees might be able to claim a credit of up to $5,000 for the costs associated with establishing those plans.
To qualify for the credit, the company must have:
- fewer than 100 employees who all were compensated at least $5,000 in the previous year
- at least one retirement plan participant who was not highly compensated
Other eligibility criteria includes employees not benefiting from another employer-offered “contributions or accrued benefits in another plan,” according to the IRS.
Health Coverage Tax Credit
For unprofitable startups, the Health Coverage Tax Credit can be especially attractive. It could help entrepreneurs recoup up to 50 percent of the premiums they pay on employee health insurance plans.
To qualify for the credit, small businesses must meet the following criteria:
- fewer than 25 full-time employees
- an average annual employee salary of $56,000 or less
- the employer pays for at least 50 percent of the full-time employees’ health insurance premium costs
- the employer offers coverage to employees through a Small Business Health Options Program
Tax audits to pad your pockets
While the IRS sets aside billions annually to help small businesses, far less is ever actually claimed by business owners.
While the purpose of a Reverse Income Tax Audit (RITA) is to identify tax underpayments, it can help small business owners identify opportunities to claim credits on state income tax overpayments. Many have found that this can be as much as 30 percent.
Typically, most companies that are in a state of transition qualify for RITA. This includes small businesses that are:
- in merger or acquisition mode
- have experienced multi-state sales
- growing and diversifying new business activities and/or operations
The bottom line
Entrepreneurs and business leaders know that running and growing a successful business takes hard work, perseverance, and a solid support system. But securing money from the government should not take much heavy lifting; it’s there for the taking.
Author – Doug Ludlow is CEO of financial services platform MainStreet.