Six Tax Credits for Schedule C Businesses without EmployeesTax Planning
Obtaining a tax credit is the next best thing to paying no taxes at all.
A tax credit is much better than a tax deduction, which only reduces your taxable income.
The tax savings you get with a deduction depends on your marginal (top) tax bracket. If you’re in the 32 percent income tax bracket, a $1,000 tax deduction will save you $320 in taxes (32 percent x $1,000 = $320).
With the tax credit, you start with the credit and then reduce, by the credit amount, the deduction that generates the credit. For example, say you have a $1,000 credit, and it reduces a deduction by $1,000. If you are in the 32 percent tax bracket, your net savings are $680 ($1,000 - $320).
In the comparison above, the tax credit is 2.125 times more valuable than a tax deduction.Therefore, if you can, go for the credit.
The tax code contains over 30 non-refundable tax credits for businesses. These are part of the general business tax credit and are claimed on IRS Form 3800, General Business Tax Credit, and on Schedule 3 of Form 1040. The general business credit is not itself a tax credit, but rather an overall limitation on the total credits that a business can claim each year.
The general business credit is limited to 100 percent of the first $25,000 of net tax liability (generally, regular tax less non-refundable personal credits) and 75 percent of any remaining net tax liability.
For example, if you owe $50,000 in tax, your general business credit limit is (1.00 x $25,000) + (.75 x $25,000) = $43,750. In calculating the limit, the credits are deducted in a specific order. If your total credits exceed the limit, you can:
- carry them back one year and claim a refund, or
- carry them forward for up to 20 years.
Each tax credit is different, with its own eligibility rules and amounts. The IRS provides you with a separate tax form to calculate each credit. But you ordinarily don’t file these forms with your return. Instead, on Form 3800, you list the amount of each credit you claim
Many of these credits are designed to help niche businesses—for example, those producing alternative fuels, maintaining railroad tracks, or producing low-sulfur diesel fuel.
What if you’re a Schedule C business owner who doesn’t have employees and isn’t involved in one of the niche businesses that come with a credit? You’re not necessarily left out of the tax credit bonanza. Here are six tax credits that many Schedule C businesses with no employees can claim (and of course, you can qualify for these credits with employees, too).
1. Credit for Increasing Research Activities
The credit for increasing research activities is intended to encourage businesses to invest in scientific research and experimental activities.
Any technological research qualifies, so long as it relates to a product’s new or improved function, performance, reliability, or quality. The research must involve the physical or biological sciences, engineering, or computer science.
The credit is not available for research in the social sciences, including economics, business management, behavioral sciences, arts, or humanities. The research must be conducted before the product is commercially produced.
The credit can be claimed for “qualified research expenses,” which include employee wages and supplies to carry on research activities.
But you don’t have to have employees to get this credit, because you can claim the credit for 65 percent of the cost of hiring third parties to perform research activities on your behalf, such as outside contractors, engineering firms, or research institutes.
Calculating the credit can be complex.
- Smaller Schedule C businesses generally claim the incremental research credit, which is 20 percent of the amount by which their research expenses for the year exceed what the business spent over a base period.
- You may also elect to use an alternative simplified credit method, which identifies a credit equal to 14 percent of the amount by which qualified research expenses exceed 50 percent of the average qualified research expenses for the three preceding tax years.
- If you had no qualified research expenses for any of the prior three years, the credit is equal to 6 percent of the qualified research expenses for the current tax year.
- If you have employees, you can use the credit to offset up to $250,000 of your employer’s share of Social Security taxes instead of applying it to your income taxes.
2. Qualified Plug-In Electric Drive Motor Vehicle Credit
Thinking about buying a car for your business?
If you purchase a gasoline-powered vehicle, you can depreciate the cost over several years. But you get no tax credits.
If you purchase a new electric vehicle, however, you may be able to claim a credit. These include fully electric vehicles (EVs) and plug-in hybrid EVs (PHEVs).
The maximum credit is $7,500, and the minimum is $2,500. But the actual amount depends on the size of the vehicle’s battery. EVs generally get the maximum $7,500, while PHEVs often qualify for less. For example, a Ford Mustang Mach-E qualifies for a $7,500 credit, while a Subaru Crosstrek Hybrid gets only $4,502.
Unfortunately, the credit phases out the year after a manufacturer reaches 200,000 total EV car sales in the U.S.
Tesla and General Motors are the only two manufacturers so far to reach the limit, and the credits for their EVs are now completely phased out. So you won’t get a federal credit if you purchase a Tesla or a Chevy Volt. Toyota and Ford will probably be next to cross the 200,000-EV threshold.
When you claim the credit for a business vehicle, you reduce the vehicle’s depreciable basis by the credit amount. You then depreciate the remaining adjusted basis as you would for any other business vehicle.
3. Disabled Access Tax Credit
The Americans with Disabilities Act (ADA) prohibits private employers with 15 or more employees from discriminating against people with disabilities in the full and equal enjoyment of goods, services, and facilities offered by any “place of public accommodation”—this includes businesses open to the public.
The disabled access tax credit is designed to help small businesses defray the costs of complying with the ADA.
But you don’t have to have employees to claim the credit. The credit may be claimed by any business with either:
- $1 million or less in gross receipts for the preceding tax year, or
- 30 or fewer full-time employees during the preceding tax year.
You can earn the credit with a variety of expenses, including the cost to remove barriers that prevent a business from being accessible to disabled people. Eligible expenses also include equipment acquisitions and services such as sign language interpreters.
But expenses to remove architectural barriers qualify for the credit only for buildings constructed before November 5, 1990.
The amount of the tax credit is equal to 50 percent of your disabled access expenses that exceed $250 in a year but are not more than $10,250. Thus, the maximum credit is $5,000.
4. Business Energy Tax Credit
There is a business energy credit based on the cost of qualified energy property used in a trade or business or for the production of income, such as a residential rental building. The credit ranges from 10 percent to 30 percent of the cost of such property.
The credit can be claimed for various types of renewable energy installations, including thermal and geothermal energy, wind turbines, and fuel cells.
But small businesses most often claim the credit for the cost of installing solar panels and related equipment to generate electricity to provide illumination, heating, or cooling (or hot water) in a business structure, or to provide solar process heat.
Unlike the solar credit for homeowners, there is no dollar limit on this business credit. The credit is 26 percent of the cost of solar property whose construction begins in 2020, 2021, or 2022.
The tax code reduces the credit percentage to 22 percent if construction begins during 2023.
IRS Notice 2018-59 states that construction begins for these purposes the year that (a) physical work commences or (b) at least 5 percent of the cost of the installation is paid.
Planning point. If the property is not placed in service before January 1, 2026, the tax code reduces the credit to 10 percent.
5. Rehabilitation Tax Credit
The rehabilitation tax credit helps defray part of the cost of rehabilitating historic old buildings. The credit is available only if you rehab a certified historic building or a building located in a registered historic district. The credit can be claimed for commercial, industrial, agricultural, and residential rental historic buildings.
The secretary of the interior must certify to the secretary of the treasury that the project meets their standards and is a “Certified Rehabilitation.” If your building is not already registered as historic but you think it should be, you can nominate it for historic status by contacting your state historic preservation office.
The credit is equal to 20 percent of the cost of rehabbing the historic structure. But to claim the credit, your rehab expenditures must exceed the greater of $5,000 or the adjusted basis of the building and its structural components.
To keep the full credit, you must hold the building for five full years after completing the rehabilitation.
6. New Energy-Efficient Home Credit
If you’re a building contractor who builds homes, there is a tax credit just for you. You can get a credit of up to $2,000 for building an energy-efficient home.
The credit is available for all new homes, including manufactured homes, built between January 1, 2018, and December 31, 2021. To meet the energy savings requirements, a home must be certified to provide heating and cooling energy savings of 30 percent to 50 percent compared with a federal standard.
A reduced credit of $1,000 is available for manufactured homes with a heating or cooling consumption at least 30 percent less than a comparable house and with the Energy Star label.
Are More Credits on the Way?
In the news, you have been reading and hearing about the Build Back Better bill that passed the House and is being considered by the Senate. There are lots of tax credits in the bill. But there are three things to know as of December 1, 2021.
- The Senate will likely create and try to pass its own version of this bill.
- If the Senate passes the bill in a different form, the bill will go to a conference with both House and Senate members, who will make more changes.
- Regardless of what happens, we don’t see any changes in the current bill or expect any changes that will affect the information in this article. The changes, if any do become law, will apply to 2022 and later.
Tax credits are far more valuable than tax deductions. There are over 30 tax credits just for businesses, but most are highly specialized or are for businesses with employees. However, there are six credits many Schedule C businesses with no employees can claim, as explained in this article.
The credit for increasing research activities can be claimed for all types of business-related technological research. You can claim the credit when you pay non-employees, such as outside contractors, engineering firms, or research institutes, to perform research activities on your behalf.
If you purchase an all-electric vehicle or plug-in hybrid, you can qualify for a credit of up to $7,500. But the credit has been used up and is no longer available for Tesla and General Motors vehicles.
If you install solar panels or other renewable energy technology in business property, you can claim a credit for up to 26 percent of the cost.
A Schedule C business also can claim tax credits for rehabbing historic buildings, making business property accessible to the disabled, and building energy-efficient homes.