Data from the US Bureau of Labor Statistics shows that about 20% of small businesses fail within the first two years and nearly half fail by the end of their fifth year. There are nearly over 32 million small businesses in the United States that employ more than 61 million people, making a business' success not only important for the individual business owner, but for also for its employees' livelihoods.
Tax deductions can go a long way toward helping a business survive those first few chaotic years. Before revealing some of the best tax deductions for small businesses, it's 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 achieve similar results in different ways. A tax deduction lowers a business' taxable income, while a tax credit reduces the amount a business owes. Think of it this way:
- A $500 tax credit issued to a business means that business lowers 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 talk to a tax professional or reach out to your local chapter of the Small Business Administration (SBA) to learn more information. Then, you can determine the best tax opportunities for your business.
These credits are mostly industry-specific, which means not all of them can be utilized by your business. They're often meant to spur businesses to conduct research or to invest in cleaner technologies. General business tax credits can often be carried forward several years and, in certain situations, can be carried back.
If you're a small business owner, chances are you've had to take out a loan. This financial burden, however, does come with a perk. The interest you pay on that loan is tax-deductible, but you need to meet certain criteria.
The loan needs to originate from a financial institution like a bank -- not from a friend or family member. You must also show the intention to pay off the loan. The amount of interest you can deduct will depend on the type of loan you have.
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 needs to be around $56,000 a year or less, and you need to pay at least half of your full-time employees' premium costs. If you qualify, you could receive a credit for up to 50% of those premiums.
Passed in 2017, the Tax Cuts and Jobs Act (TCJA) is the largest tax reform the US has seen in decades. It changed "deductions, depreciation, expensing, tax credits, and other tax items that affect businesses," according to the IRS. You can click on this link to learn more.
Small businesses are often set up as pass-through entities, meaning the tax burden falls on the business owner. The TCJA (mentioned above) created a new deduction for those who earn income through pass-through entities. Qualifying individuals are now able to deduct up to 20% of their business income.
The Work Opportunity Tax Credit (WOTC) is a federal initiative, providing opportunities for those who have historically run into barriers when seeking employment. This group includes veterans and the formerly incarcerated. Small business owners can receive up to $9,600 in credits for each new hire covered by this program.
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 is applied to their federal income tax.
[This article originally appeared on the Simple Dollar in September, 2020. It was updated in December, 2021.]