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Getting credit when credit is due is always satisfying--especially if you're calculating your federal tax liability. While tallying up tax deductions trims your tax bill, earning tax credits saves you even more.
"A dollar's worth of tax credit reduces your tax bill by one dollar, but a dollar's worth of deductions [only] lowers your tax bill by whatever percent your tax bracket is. If you're in the 28 percent tax bracket, for example, a tax deduction saves you 28 cents,' explains Susan Jacksack, a small-business analyst with CCH Inc., a Riverwoods, Illinois, provider of legal, tax and business information.
In light of this, entrepreneurs are advised to be on the lookout for tax credits they can use. "We are quite convinced that many business owners don't claim their share of tax credits,' says Thomas P. Ochsenschlager, a partner in accounting firm Grant Thornton. That's because they don't think they qualify or they're put off by the complexity of claiming a specific credit.
Ochsenschlager cites the research and development (R&D) credit and the welfare-to-work credit as two that are often overlooked by business owners. "We find this to be the case when we get new clients who were previously with small, local accounting firms. [Accountants] don't seem to be very aggressive in trying to qualify their clients for credits,' he maintains. That's unfortunate, because it means a loss of some valuable tax savings.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 12 years.
It's Worth Researching
With the R&D credit, recently extended through June 30, 1999, by the Omnibus Consolidated and Emergency Supplemental Appropriations Act of 1999 (better known as the omnibus budget act), companies are allowed to take a 20 percent credit for research and development costs above a base amount of up to 50 percent of their current research expenditures.
"A lot of companies don't know what activities qualify as research. Those who do may only know they get a deduction for it and aren't aware they may be eligible for a credit," Ochsenschlager says. In fact, the R&D credit may be available to business owners for a portion of the money they've spent on efforts to improve a product or deliver a service more efficiently.
The welfare-to-work credit is a relatively new credit employers can take for wages paid to qualified, long-term family assistance recipients who began working for the company after December 31, 1997, and before May 1, 1999. The credit is figured on the first $20,000 of qualified wages paid to an employee during the first two years of employment. In the first year, the credit is 35 percent of the first $10,000 in qualified wages paid to a qualifying employee. In the second, the credit is 50 percent of the first $10,000 of wages, resulting in an $8,500 maximum total credit for each qualified employee for the two years.
Ochsenschlager says a fair number of companies never bother to find out whether individuals they hire have been on welfare. As a result, these companies lose partial credit for the wages paid to employees transitioning off welfare.
Similar to the welfare-to-work credit is the work-opportunity credit. While it doesn't provide as much tax savings as the welfare-to-work credit, it can still put a good number of dollars back in your pocket. There are several important dates to keep in mind here. If you have hired individuals from special targeted groups with high unemployment rates or other special employment needs, you'll receive a credit equal to 35 percent of the first $6,000 of wages paid to these employees if they were on your payroll before October 1, 1997. The maximum credit for each individual is $2,100. Targeted groups include qualified veterans and high-risk youths.
If the employee began work at your company after September 30, 1997, and has worked for you for at least 400 hours, the credit would equal 40 percent of the employee's qualified first-year wages, according to the IRS. Unless extended by Congress, employees in this category hired after June 30 of this year don't qualify.
Also keep in mind that an employee may not be considered a member of a targeted group unless certified as such by your state employment security agency. You can satisfy this requirement by requesting certification from your state employment agency, stating the individual is a member of a targeted group. It's also possible to get the employee certified by completing Form 8850 and sending it to your state employment security agency no later than the twenty-first day after the individual begins work.
You must have the certification before claiming the credit. While the welfare-to-work and work-opportunity credits are similar, you can only claim one.
Even though claiming a credit may require more work than claiming a standard business deduction, especially on the part of your accountant, it's worth the effort, says Jacksack. This is especially true if you've hired several individuals from targeted groups.
Running a Credit Check
Although a good number of credits are available in specialized targeted industries or locations, some have a wider application. Here are two examples:
1. Disabled Access Credit. Business owners are allowed to claim 50 percent of expenses, up to $10,000, when renovating their workplace to accommodate the disabled, Jacksack explains. As you know, the Americans with Disabilities Act requires companies to remove physical barriers to the disabled.
Unless business owners choose first-floor offices, improving access for the disabled is something they have to do anyway, says Jacksack. However, the disabled access credit doesn't apply to costs associated with constructing a new building and making it accessible to the disabled.
2. Employee Tip Credit. Widely used by owners of restaurants, bars and other establishments where employees receive tips, the employee tip credit is generally equal to the employer's portion of Medicare and Social Security taxes paid on tips received by employees in these businesses. The credit applies regardless of whether food is consumed on or off the premises.
The employee tip credit prevents an employer paying a minimum wage from incurring adverse consequences because of the employees' tips, says Jacksack. "The employee gets credit toward retirement benefits," Jacksack explains, "but the employer doesn't have to pay for it."
When claiming credits, keep in mind that if you qualify for more than one, the credits have to be combined into one general business credit and entered on Form 3800 (with the exception of the empowerment zone employment credit).
Remember that the combined business credit is subject to a limitation based on tax liability. There is also an important caveat to keep in mind when claiming tax credits. Taking too many of them may make you vulnerable to the dreaded alternative minimum tax. Your accountant can provide more information about this tax and help you assess your risk.
If you've checked out all the potential credits and find you don't qualify, there are still those tried-and-true business deductions. For example, you can deduct employee salaries, wages and fringe benefits. You can also deduct payments to employee benefit programs, such as educational assistance, group-term life insurance and group health plans.
You may also want to consider employing your spouse, if he or she is available. Under federal law, you may claim a business deduction for reasonable wages paid to your spouse for work he or she does for your business. In addition, because these wages are subject to FICA taxes, they may qualify your spouse for certain Social Security benefits he or she would not otherwise receive. A spouse working in your business may be entitled to coverage under your company's qualified retirement plan. You also may receive a business deduction for health insurance premiums made for your employed spouse. Providing your spouse with family health insurance coverage as an employee increases your business deductions while maintaining the same family coverage.
You should also think about hiring one of your children under the age of 18. He or she would not be subject to FICA taxes, and you would consequently not be responsible for paying the employer's portion of these taxes. You're allowed to take a tax deduction for the wages paid to your child, and the child's 1998 standard deduction will shelter the first $4,300 of wages from tax.
While credits are worth more, don't ignore valuable deductions. Together, they deliver the one-two punch you'll need when tax time rolls around.
CCH Inc., 2700 Lake Cook Rd., Riverwoods, IL 60015, http://www.toolkit.cch.com
Grant Thornton LLP, 1707 L St. N.W., #230, Washington, DC 20036, http://www.gt.com