Tax Credits Guide

Tax Credits Guide

August 16, 2022

What Is a Tax Credit?

A tax credit is money you can subtract, dollar for dollar, from income taxes that a business or individual owes. Tax credits incentivize investment or provide assistance in these areas:

In this guide we'll cover the fundamentals of tax credits:

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How Do Tax Credits Work?

Tax credits are defined and updated throughout the year by both federal and state governments. Qualifying businesses and individuals must typically file a form to claim tax credits; the savings are not automatic. The claim process varies by tax credit.

Tax credit differences for consideration:

  • Some credits expire, while others are permanent
  • Some credits can be combined for additional tax savings
  • Some credits are one-time only, while others can be claimed multiple times
  • Some credits have maximum savings allotted, while others have no limit

What Are Different Types of Tax Credits?

Tax credit types are designated as refundable, partially refundable, or nonrefundable – all offer a chance to lower the amount of taxes owed. “Refundable tax credits” will generate a refund (cash back to you) if the credit amount is larger than the tax amount you owe. If you don’t owe any taxes, you’ll receive a money-back refund for the amount of the refundable tax credit.

Most tax credits are nonrefundable. Some tax credits include both refundable and nonrefundable portions.

Refundable Tax Credit Examples:

  • Small Business Health Care Tax Credit
  • Indian Employment Credit
  • Historic Preservation Tax Credit
  • Paid Leave Credit for Vaccines
  • Employer Credit for Family and Medical Leave
  • Paid Sick & Family Leave Credit
  • Employer-Provided Child Care Tax Credit

Nonrefundable Tax Credit Examples:

  • Electric Vehicle (EV) Tax Credits
  • Solar Tax Credit
  • Work Opportunity Tax Credit (WOTC)
  • R&D Tax Credit
  • Low-Income Housing Credit (LIHTC)
  • New Markets Tax Credit
  • FICA Tip Credit
  • Disabled Access Credit
  • Empowerment Zone Credit
  • Energy Investment Tax Credit
  • Renewable Electricity Production Tax Credit (PTC)
  • Biodiesel and Renewable Diesel Fuels Credit
  • Retirement Plan Startup Credit

Partially Refundable Tax Credit Examples:

  • Employee Retention Credit
  • American Opportunity Tax Credit
  • Child Tax Credit
  • Alternative Fuel Vehicle Refueling Property Credit

For complete listings or details of these tax credits, see Business Tax Credits 2022 and California Tax Credits.

Tax Credit vs Deduction

Tax credits reduce your tax liability (the amount of tax you owe), while tax deductions reduce your taxable income. Tax credits are usually more valuable than tax deductions of the same amount.

The example below shows how a tax credit and a tax deduction of the same amount impact your tax bill differently. (Note that this simplified example uses a flat tax rate of 15% and does not reflect the progressive income tax rate structure currently in effect in the U.S.)

Tax Credit of $10,000 Tax Deduction of $10,000
Total Income $100,000 $100,000
Taxable Income $100,000 $100,000 (- $10,000 tax deduction)
Calculated Tax 15% of $100,000 15% of $90,000
Tax Liability $15,000 (- $10,000 tax credit) $13,500
Total Tax Bill $5,000 $13,500

Tax Credits vs Other Tax Breaks

Tax Credit vs Write-Off

A tax write-off (also known as “tax deduction”) is an expense you can deduct from your taxable income, such as equipment and supplies for your business. Tax deductions or write-offs reduce your taxable income before the tax on it is calculated. Tax credits are subtracted, dollar for dollar, from the tax you owe after it has been calculated.

Tax Credit vs Tax Exemption

A tax exemption is a type of tax deduction (e.g., the standard deduction). Taxpayers can deduct the amount of the exemption from their taxable income. As with other types of tax deductions, tax exemptions are less valuable than tax credits, which can be subtracted from the amount of tax owed on a dollar-for-dollar basis.

Tax Credit vs Refund

When you pay more tax during the year than you owe, you can receive a refund for the amount you overpaid. Some tax credits are refundable, in which case if the tax credit exceeds the tax amount you owe, you’ll receive a tax refund for the difference.

Tax Credit vs Rebate

On rare occasions, federal or state tax agencies give back some of the money that taxpayers have already paid in taxes as a rebate. Some states also offer rebates to taxpayers who purchase alternative energy products or other specified consumer goods.

Tax Credit vs Tax Cut

A tax cut is when state or federal tax authorities reduce the tax rate that individuals or businesses must pay. For example, the Tax Cuts and Jobs Act of 2017 lowered the highest corporate income tax rate to 21% from 35%. Tax cuts reduce the tax rate for everyone in the impacted group, but tax credits only provide savings for qualified taxpayers.

Tax Credit vs Subsidy

A tax subsidy is money that a government pays to or for a business or individual for a specific purpose. Individual companies and industries often receive tax subsidies for locating in a specific area, creating jobs or many other reasons. For example, the Affordable Care Act’s cost-sharing subsidies reduce the cost of care for policy holders by requiring the federal government to pay some of the cost directly to the insurance company.

When to Consider Tax Credits?

Strategic tax planning takes advantage of tax savings to help your business be more profitable, competitive, and financially successful. Many different business activities and events can trigger eligibility to claim business tax credits. Consider these events in advance to reap optimal tax credit savings.

  • Workforce Changes. Whether you’re expanding your workforce or struggling to retain employees, job tax credits for hiring and retention can assist.
  • Employee Benefits. Providing benefit plans and training might be more affordable than you think. Businesses can claim employer tax credits for providing benefits like health insurance, childcare, pension plans, training, paid leave and more.
  • Research. Exploring new or improved products or better methods of production can qualify your business for research and development tax credits, including a payroll tax credit for small businesses.
  • Expansion. As your business facility or offices need to grow, consider tax credits for new construction investments in opportunity zones or qualified new markets. If you’re expanding your company car fleet, be sure to consider energy efficient vehicle tax credits.
  • Building Renovation. Planning a remodel? Housing tax credits are available for businesses that increase accessibility, improve energy efficiency or rehabilitate historic buildings.
  • Disaster. When times get tough, disaster relief tax credits can help your business stay strong through severe weather events, fires, and even pandemics like COVID-19.

Tax credit strategy can be confusing and complicated. Check out our tax credit services to help maximize your credits and ensure compliance.

The information contained on this page is for general guidance on matters of interest only. As such, it should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisers. Before making any decision or taking any action, you should consult an Armanino tax consultant.

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