Tax Credits for Schedule C Business Owners with Employees

Congress encourages businesses to hire employees and provide them with various benefits.

If you hire an employee for your Schedule C business, you can qualify for several valuable tax credits.

Except for the temporary COVID-19-related credits discussed later in this article, these are all non-refundable credits that cannot exceed your tax liability. The general business credit collects them, along with 24 other credits, and then imposes an overall limit, as we explain.

You report the credits on IRS Form 3800, General Business Tax Credit, and on Schedule 3 of Form 1040.

Each credit is different. But certain limitations apply to all or most employer tax credits.

No Multiple Credits for the Same Wages

Generally, you cannot use the wages used to calculate one wage-based credit for another wage-based credit.

For example, you can’t claim the Work Opportunity Tax Credit (WOTC) and the Empowerment Zone Employment (EZE) credit for the same wages. But this doesn’t prevent you from claiming more than one wage-based credit for the same employee. You may do so, provided the same wages are not used to calculate each credit.

For example, you may claim the WOTC and the EZE credit on wages paid to the same employee, provided that any wages used to calculate the WOTC are not also used to calculate the EZE credit.

No Double Tax Benefit Allowed

Ordinarily, you may fully deduct the total wages you pay to your employees. But you must reduce your deductible wages by the amount of any wage-based employer credit you claim.

For example, you reduce the wages you report on line 26 of Schedule C for the following tax credits that you claim:

• WOTC
• Employee retention credit
• EZE credit
• Indian employment credit
• Credit for employer differential wage payments
• Family and medical leave credit

Remember, tax credits are the best. They beat deductions. Note the difference below (using the 32 percent bracket):

• A $1,000 deduction for wages reduces your income taxes by $320.
• A $1,000 credit reduces your taxes by $680 ($1,000 - $320).

The expense reduction for tax credits applies to costs other than wages. For example, if you claim a $500 credit for small employer pension plan start-up costs, you may not deduct $500 of your out-of-pocket costs to set up the pension plan, but you may deduct amounts over $500.

No Credits for Employees Related to You

Many tax credits are not available if you hire a person related to you, including children, stepchildren, a spouse, parents, siblings, step-siblings, nephews, nieces, uncles, aunts, cousins, or in-laws. The credits denied for your relatives include the following:

• Small employer health insurance credit
• Work Opportunity Tax Credit
• Empowerment Zone Employment credit
• Employee retention credit
• Indian employment credit

Eight Valuable Tax Credits for Business Owners

Below we describe the eight non-refundable tax credits that Schedule C business owners can claim when they hire employees.

1. Work Opportunity Tax Credit

The WOTC rewards employers for hiring employees from groups the IRS has identified as having “consistently faced significant barriers to employment.” These include the following:

• Veterans
• Formerly incarcerated individuals or ex-felons hired within one year after their date of conviction, work release, or release from prison or jail
• Public assistance recipients, if they meet the eligibility requirements for SNAP (Supplemental Nutrition Assistance Program, or “food stamps”) or TANF (Temporary Assistance for Needy Families)
• Qualified Supplemental Security Income (SSI) recipients, if a month for which this person received SSI benefits is within 60 days of the date this person is hired
• Residents in areas designated as empowerment zones or rural renewal counties
• People with disabilities participating in state or federal vocational-rehabilitation programs who’ve had an “individual written plan” for employment in the two years before being hired
• Summer youth employees hired May 1 to September 15 (limited to 16-to-18-year-olds who live in an empowerment zone, an enterprise community, or a renewal community)
• Long-term unemployment recipients (must have been unemployed for at least 27 consecutive weeks)

You can claim a WOTC equal to 40 percent of up to $6,000 in wages paid to an employee who

• is in their first year of employment,
• is certified as being a member of a targeted group, and
• performs at least 400 hours of service.

Thus, the maximum tax credit is generally $2,400. But the credit is larger for disabled veterans—40 percent of up to $24,000 in wages, for a $9,600 maximum. The credit is reduced to 25 percent of up to $6,000 paid to employees who work between 120 and 400 hours. You can’t claim the credit for employees you rehire.

To qualify for the credit, you must prescreen job applicants to make sure they are in one of the targeted groups. You and the applicant must complete IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, and you must complete Department of Labor Form 9061, which contains basic information about the applicant and employer.

You then submit both forms to your state workforce agency within 28 days after the employee’s start date. The agency must certify that the employee is a member of one of the targeted groups.

2. Family and Medical Leave Credit

Federal law doesn’t require that you give paid leave to your employees who need to take time off for family reasons (such as the birth of a child) or due to their illness or that of a family member. (A few states require some paid leave that’s funded through payroll deductions.)

But if you choose to provide such paid leave, the federal tax code may reward you with a family and medical leave tax credit.

This credit is separate from the temporary pandemic-related family and medical leave credit, which ended September 30, 2021. You can’t take both credits for the same wages.

The family and medical leave credit is scheduled to last through 2025.

To claim the credit, you must

• offer your employees a minimum of two weeks of paid leave for one of the reasons listed below;
• pay at least 50 percent of employees’ regular earnings while they are on leave;
• allow part-time employees to take paid leave on a pro rata basis; and
• have a written paid leave policy.

You may claim the credit only for leave provided to employees who have been on your payroll for at least one year and who are paid no more than $78,000 per year (adjusted for inflation each year).

You may claim the credit if you provide paid leave to a qualifying employee for any of the following reasons:

• The birth or adoption of a child of the employee and the care of that child
• The care of the employee’s spouse, child, or parent, if such person has a serious health condition
• The employee’s inability to work due to a serious health condition
• The covered active duty in the armed forces of the employee’s spouse, child, or parent
• The care of a covered armed forces service member or veteran with a serious injury or illness if the employee is the service member’s spouse, child, parent, or next of kin

The credit ranges from 12.5 percent to 25 percent of the amount of wages paid to the employees while they’re on leave. The credit goes up by 0.25 percentage points for each percentage point the rate of payment exceeds 50 percent.

Example. If you pay an employee $1,000 for two weeks of paid leave and this is 50 percent of her regular wage, your credit is 12.5 percent of $1,000, or $125. If the $1,000 payment is 75 percent of the employee’s wage, the credit is 18.75 percent of $1,000, or $187.50.

3. Credit for Small Employer Health Insurance Premiums

If you have fewer than 50 full-time-equivalent employees, you are not required to provide your employees with health insurance. But if you elect to do so, you may qualify for the small business health care tax credit. This tax credit is available to eligible employers for two consecutive tax years.

The credit is equal to 50 percent of the premiums small employers pay for their employees’ health insurance. To qualify for the credit, you must 

• have no more than 25 full-time-equivalent employees (a full-time employee works at least 2,080 hours);
• pay average annual full-time wages of less than $55,600;
• pay at least 50 percent of the annual premiums for your employees’ health insurance; and
• purchase your employees’ health insurance through a Small Business Health Options Program (SHOP) Marketplace (these are health insurance exchanges specifically designed for employers with 50 or fewer full-time employees; see https://www.healthcare.gov/small-businesses/employers/).

Planning point. Your credit begins to phase out if you have more than 10 employees or if the average annual wages of the employees exceed $27,800.

4. Credit for Small Employer Pension Plan Start-Up Costs

This credit is for the cost of setting up an employee pension plan, including a new 401(k) plan, 403(b) plan, defined benefit plan (a traditional employee pension plan), profit-sharing plan, SIMPLE IRA or SIMPLE 401(k), or SEP-IRA.

The costs covered by the credit include the expenses to establish and administer the plan and to educate employees about retirement planning.

You qualify for this credit only if (1) you have 100 or fewer employees who were paid at least $5,000 each, and (2) at least one plan participant is a non–highly compensated employee. You must not have had a retirement plan in place in the prior three years covering substantially the same employees as the new plan being set up.

The credit is equal to half your eligible start-up costs, up to the greater of

• $500, or 
• the lesser of (a) $250 for each non–highly compensated employee eligible to participate in the plan, and (b) $5,000.

Thus, the maximum credit is $5,000, and the minimum is $500. You can claim the credit for the first three years of the plan, and you may choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

If you add an auto-enrollment feature to your plan, you can claim an additional $500 credit for three years.

5. Credit for Employer-Provided Childcare Facilities and Services

This little-used credit is intended to encourage employers to provide childcare to their employees. There are two ways to get the credit:

1. Build, acquire, rehabilitate, or expand an on-site childcare facility for your employees’ children, and help pay to operate it.
2. Contract with a licensed childcare program, including a home-based provider, to provide childcare for your employees.

The second option is more realistic for smaller businesses. Businesses often partner with childcare companies such as the Learning Care Group, Bright Horizons, and KinderCare to offer this benefit.

You can claim a credit equal to 25 percent of your contributions for childcare facilities and services. You can also claim a credit for 10 percent of the cost of offering your employees childcare resources and referral information.

This includes amounts paid under a contract to help employees find childcare.

The total credit is capped at $150,000 per year.

6. Empowerment Zone Employment Credit

Is your business located in one of the designated empowerment zones?

These are areas of high poverty and unemployment identified by the U.S. Department of Housing and Urban

Development or Secretary of Agriculture. You can find a list and map on the HUD website.

Key point. You might be surprised which places the government designates as having high poverty and unemployment. It’s worth checking out.

You can claim a credit equal to 20 percent of the first $15,000 in wages you pay to full- or part-time employees who both live and work in an empowerment zone. Thus, the maximum credit is $3,000 per employee (20 percent x $15,000). The employees must work for you for at least 90 days.

7. Credit for Employer Differential Wage Payments to Military Personnel

This credit is available if you have an employee in the military reserves who is called to active duty for more than 30 days. If you continue to pay the employee all or part of that employee’s wages while he or she is on active duty, you can claim a credit equal to 20 percent of the payments, up to $20,000.

8. Indian Employment Credit

This credit is available only if you hire an enrolled member of an American Indian tribe who both lives and works on an Indian reservation. If this is the case, you may claim a tax credit equal to 20 percent of the wages and health insurance benefits you provide the employee. The Indian employment credit ends December 31, 2021.

Temporary Coronavirus-Related Employer Tax Credits

Due to the COVID-19 pandemic, Congress created two temporary tax credits designed to encourage employers to keep their employees on the payroll and provide them with COVID-19-related paid family and sick leave.

Unlike the other credits covered here, these credits are not part of the general business credit.

Also, they are refundable credits that can exceed an employer’s tax liability. Employers could claim them in advance by reducing their payroll tax deposits. Both credits ended September 30, 2021.

Employee Retention Credit

The CARES Act created this payroll tax credit for businesses that closed or experienced a significant decline in sales due to the COVID-19 pandemic (For details on the employee retention credit, see Don't Miss Out on the Employee Retention Credit.)

• The initial credit began March 12, 2020, and ended December 31, 2020. The maximum credit was $5,000 per employee.
• The credit was extended to 2021 by the American Rescue Plan Act and increased to $7,000 per quarter for each employee.
• Except for tax code–defined recovery start-up businesses that began after February 15, 2020, the employee retention credit ended September 30, 2021.
• The credit continues through December 31, 2021, for start-up businesses.

Family and Medical Leave Credit

The Families First Coronavirus Response Act generally required employers with fewer than 500 employees to provide paid leave in 2020 due to COVID-19, including for illness, quarantine, getting tested, or caregiving.

The American Rescue Plan Act provided a similar credit for qualified paid leave at any time between April 1, 2021, and September 30, 2021, including paid leave for COVID-19 vaccinations. The credit was equal to 100 percent of the sick and family leave wages paid each quarter, up to $511 per day for leave taken for the employee’s own illness or quarantine and $200 for leave taken to care for others.

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.

1. The Senate will likely create and try to pass its own version of this bill.
2. 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.
3. Regardless of what happens, we don’t see any changes in the current bill or expect any that will affect the information in this article. The changes, if any do become law, will apply to 2022 and later.

Takeaways

The incredibly valuable employee retention credit ended September 30, 2021 (except for start-up businesses), as did the pandemic-related family and medical leave credit. But there are eight other credits you can claim when you hire an employee to work in your Schedule C business. And you may be able to claim more than one.

These eight employer credits are all part of the general business credit and are non-refundable—they may not exceed your annual tax liability.

You can qualify for more than one employer credit. But employee wages you use to calculate one wage-based credit cannot be used to calculate other wage-based credits.

Many of these credits may not be claimed for employees who are related to you.

Here are the eight non-refundable credits from this article that are part of the general business credit:

1. Work Opportunity Tax Credit
2. Family and medical leave credit
3. Credit for small employer health insurance premiums
4. Credit for small employer pension plan start-up costs
5. Credit for employer-provided childcare facilities and services
6. Empowerment Zone Employment credit
7. Credit for employer differential wage payments to military personnel
8. Indian employment credit

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