Tax Planning for Small Businesses: Credits & Deductions to Know

Tax planning for small businesses

Author: The Carta Policy Team
Read time: 6 minutes
Published date: October 13, 2023

Small businesses owners and entrepreneurs can use these tax planning strategies to save on taxes and maximize business growth.

While you might think of paying taxes as just another cost of doing business, seasoned entrepreneurs understand that annual tax planning is a strategy that can position a business for growth.

Congress regularly passes new small business tax incentives to promote specific business behaviors and accomplish long-term goals, like shoring up Americans’ retirement savings. Over the past several decades, those incentives have focused on supporting the development of startups, which have the potential to create more jobs—or entirely new industries.

In this article, we’ll highlight some incentives that can be really helpful to small businesses. We’ll also walk through some strategies that can help lower your tax burden and provide more benefits to your employees—both of which can help your business grow stronger in the coming tax year.

Important note: While we’re here to help you understand different small business tax incentives, we aren’t giving tax advice in this article. You should definitely check in with your own tax advisor.

Tax deductions and tax credits: What’s the difference?

Tax incentives often take the form of deductions or credits.

A tax deduction is an expense that a taxpayer or business can subtract from their income before applying a tax rate to calculate the total amount of tax owed.
A tax credit reduces the amount of taxes you may owe on a dollar-for-dollar basis.

Small business tax deductions

Business startup and organizational costs

Your first year of business presents a unique tax opportunity to consider. Normally, startup and organizational costs are generally capital expenditures—meaning that the IRS requires them to be amortized, or written off your business income, in equal amounts over a period of 180 months. But in the first year your business begins, you can elect to deduct up to $5,000 of startup and $5,000 of organizational costs on your tax return, without waiting.

Qualifying startup costs include analysis of potential markets, advertisements, employee training, rent, and other consultant fees. Organizational costs include the costs of creating a partnership or corporation, such as the cost of temporary directors, state incorporation fees, and legal services.

Capital investments

Investing in capital can also have tax benefits. The Tax Cuts and Jobs Act (TCJA) increased the maximum section 179 deduction from $500,000 to $1 million. Most small businesses can deduct up to $1 million (indexed for inflation) when investing in equipment for business use. The IRS’s definition of equipment includes technology, machinery, furniture, and vehicles.

Section 179 allows businesses to take an immediate deduction for expenses related to eligible property, such as equipment, refrigerators, or off-the-shelf computer software. This gives you the ability to lower your current year tax liability. Otherwise, you’d wait to capitalize an asset and depreciate it over the useful life of that asset in future tax years.

For example, imagine you paid $100,000 for a five-year subscription to a SaaS payments processor for your new business, and you want to deduct that expense right away. Typically, you’d capitalize it over the next five years by deducting $20,000 this year, $20,000 next year, and so on. The Section 179 deduction could allow you to deduct the full $100,000 in the first year.

As an added incentive, the full deduction applies to equipment purchases that are financed, as long as the assets are put into service by the end of the year.

Tax credits for small business retirement plans

The SECURE Act enhanced tax credits for small businesses that set up a retirement plan for their employees.

The retirement plans startup costs tax credit: Eligible employers can claim a credit of up to $5,000, for three years, for the ordinary and necessary costs of starting a small business retirement plan. These plans include SEP, SIMPLE IRA, and qualified plans, including 401(k) plans.
Auto-enrollment credit: Employers can receive an additional $500 tax credit, for three years, by adding an automatic enrollment feature to a new or existing plan.
Employee contribution match credit: If you choose to match contributions for your employees, your business can take a 100% tax deduction, up to an annual limit, on all employer contributions.
Business owner retirement contributions: If you’re a business owner, you can deduct contributions to your own retirement plan for the year you contributed to the plan (subject to IRS rules on self-employed plan contribution and deduction).

Both employee and employer contributions for a certain tax year can be made up until the return deadline of that tax year, including extensions. For example, contributions for tax year 2021 can be made in 2022, up until your extended tax return deadline, if you file a timely extension.

Work Opportunity Tax Credit (WOTC)

Hiring decisions can have tax benefits, as well. Eligible employers may claim up to $9,600 for each qualified employee hired under the Work Opportunity Tax Credit ( WOTC) program. Employers can claim this credit for hiring and paying wages to employees who begin work on or before December 31, 2025, and are members of a targeted group under section 51 of the internal revenue code. Groups include people who are leaving the military, coming off welfare, or have been unemployed for more than six months.

The WOTC is available to employers of all sizes, including taxable and certain tax-exempt businesses. To claim this credit, the job applicant needs to give information to the employer on or before the day a job offer is made. This gets entered on Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit). If, as an employer, you believe the applicant is a member of a targeted group, you must complete the remainder of the form no later than the day the job offer is made. Both the job applicant and the employer must sign Form 8850; the employer then has 28 days from the new employee’s start date to submit the completed Form 8850 to a designated state workforce agency.

Employer-provided educational assistance

Various incentives help business owners build strong teams and retain talent.

Employee education: The IRS allows employers to take a payroll tax exclusion up to $5,250 per employee, each year, if they provide an educational assistance program to their employees. The $5,250 is also tax-free to the employee, meaning they don’t have to claim it as income. Eligible expenses generally include costs of books and tuition for instruction or training that improves or develops an employee’s capabilities (including graduate-level courses).
Student loan repayments: In 2020, the CARES Act created a new provision that allows employers to make student loan repayments of up to $5,250 per employee, each year, either directly to the employee or their student loan servicer. Like the educational assistance program, the employer gets a payroll tax exclusion for the amount of loan repaid, and the employee gets the benefit tax-free.

Providing tuition reimbursements and student loan repayments can help your workforce gain new skills and attain higher degrees; it’s also a benefit that many employees would value.

Inflation Reduction Act: new small business incentives

The Inflation Reduction Act of 2022 (IRA) introduced several provisions that can save small business owners on taxes:

Qualified small business (QSB) payroll tax credit for increasing research activities: The IRA increased the maximum amount of R&D credit that a QSB can use to offset certain payroll tax liabilities to $500,000 for tax years beginning after December 31, 2022. This could be a valuable incentive for startups that currently have net operating losses (NOLs) for federal tax purposes and would like to benefit from the R&D credit in the near term.
Clean energy tax credits: Small businesses can receive a tax credit covering up to 30% of the cost of switching over to renewable energy, including solar and wind power.
Energy efficient commercial buildings deduction: Small business building owners can receive a tax credit up to $5 per square foot to support energy efficiency improvements that deliver lower utility bills.
Clean commercial vehicle credit: Small businesses that use vehicles such as trucks and vans can benefit from tax credits up to 30% of purchase costs for clean commercial vehicles, including electric and fuel cell models that meet certain IRS requirements. There is no limit on the number of Clean Commercial Vehicle credits a business can claim.
Previously-owned clean vehicles credit: Employers can receive a credit of up to $4,000 for the purchase of a previously-owned clean vehicle with a sale price of $25,000 or less.

We hope these insights inspire you to consider new tax opportunities and encourage you to include tax planning as an integral part of your small business’s success.