Complete Guide to Tax Credits and Tax Deductions

Every business must pay tax, but even minor mistakes can have a significant impact on profit margins. If you’re an employer or work in HR, understanding tax credits and deductions can help make sure your company receives the benefits it’s entitled to.

With so many types of tax credits, things can quickly get complex. Incorrect claims for tax refunds or credits can carry a penalty of up to 20% of the amount claimed—so it’s essential you understand how to accurately claim any tax credits and deductions.

In this guide, we’ll explain the different types of tax credits and deductions, along with key considerations for each.

What are tax credits?

A tax credit is an amount of money a business can subtract from its tax liability, dollar-for-dollar. Put simply, tax credits directly reduce the amount of tax owed. Unlike tax deductions, which reduce taxable income, credits lower the tax bill itself. Here’s what that might look like:

• A company’s tax liability is $1,000,000
• It successfully claims tax credits totaling $250,000.
• The business now owes $750,000 in tax, instead of $1,000,000.

The federal government offers business tax credits to encourage behaviors that benefit society. These include stimulating the economy, investing in clean energy or reforestation, providing access to people with disabilities, supporting underrepresented groups, and rehabilitating historic buildings. Find out more about these types of business tax credits from the IRS website.

The total tax deduction a business can claim is based on several factors, including total business income, filing status and strict eligibility criteria. Many tax credits are capped or must be claimed within a specific timeframe. Find out more about tax credit deductions.

For information on Earned Income Credit (EIC) for workers, visit our glossary page.

What is the difference between a tax credit and a tax deduction?

Both tax credits and tax deductions can lower a business’s tax liability, but they work in different ways.

A tax credit is a dollar-for-dollar reduction of the amount of money the business owes to the IRS, while a tax deduction lowers the amount of taxable income the company has in the first place. This in turn usually reduces the total taxes owed by a business.

For example:

• A transportation company earning $25,000,000 per year has a $500,000 vehicle depreciation tax deduction.
• This reduces its taxable income to $24,500,000, so they only pay taxes on that amount.

Much like tax credits, there are different types of tax deductions. Above-the-line deductions get subtracted from the company’s income before calculating the adjusted gross income (AGI), whereas below-the-line deductions are subtracted from its AGI.

How much of a tax deduction the business qualifies for depends on several factors. Some deductions, like the standard mileage rate, are fixed, while others depend on business expenses.

Types of tax credits for businesses

There are three main categories of tax credits for businesses. Each one affects the maximum amount that can be applied to taxes and how they’re paid:

Refundable tax credits

Refundable tax credits are paid out in full to businesses, even when the credit is greater than the tax owed. This means that if the credit were to be enough to reduce the company’s tax liability to nothing, the business would receive a refund of whatever is left. That refund could not be applied to the tax liability (the amount of tax owed).

For example:

• A company with $450,000 in tax liability
• It receives a tax credit worth $500,000
• The business would pay no taxes and receive a refund for the remaining $50,000.

Business tax credits are not typically refundable. A recent example of a refundable business tax credit was the Employee Retention Tax credit, which was available through 2021 for employers who continued paying employees during the global health emergency.

Partially refundable tax credits

Partially refundable tax credits let a business receive only a partial refund when their tax credit exceeds their tax liability. The IRS may cap the refund at a specific amount or allow only a percentage of the excess to be refunded to the business.

For example:

• A business has $450,000 in tax liability.
• It receives a $600,000 partially refundable tax credit.
• Only a portion of the remaining $150,000 may be refunded, depending on IRS limits.

Partially refundable tax credits are nearly as rare as fully refundable ones. The Research and Development Tax credit, which is for companies conducting research or developing new products, allows a portion of the credit to be applied to a future tax year. However, the business will not receive a monetary refund.

Non-refundable tax credits

Non-refundable tax credits are the most common type of business tax credit. These credits allow the business to reduce its tax liability to zero, but with no refunds. That means there will be no refund—not even a partial one—if the amount of the credit exceeds that of the liability.

For example:

• A business owes $450,000 in taxes
• It receives a $600,000 non-refundable tax credit
• The liability is reduced to zero, but no refunds will be issued for the remaining $150,000.

Some non-refundable tax credits expire if unused, while others may be carried forward to future years.

While this process might sound pointless, it’s important to remember that tax credits still reduce a company’s tax liability, which brings significant cost savings. They also help the government incentivize investments in certain areas, like the economy or environment.
There are plenty of non-refundable tax credits available for businesses of all sizes.

One example is the Work Opportunity Tax credit, which offers up to 40% of wages paid to individuals hired from certain targeted groups. Though the WOTC expires December 31, 2025, there is bipartisan support to expand and extend it, though some criticize its efficacy.

What other tax incentives are there for employers?

There are many ways for businesses to reduce their tax burden, but these opportunities are often overlooked. With the wide range of tax credits and deductions available for different actions, companies might not be aware of the tax relief they can claim. Here are some tax incentives available for businesses:

• Work Opportunity Tax credit. The Work Opportunity Tax credit (WOTC) has been extended until December 31, 2025, and is offered to employers who hire individuals facing barriers to employment. This includes veterans, ex-felons within one year of release, or those receiving Temporary Assistance for Needy Families.
• Disabled Access Credit. The Disabled Access Credit gives small businesses a non-refundable tax credit in return for providing access to those with disabilities. To be eligible, a business needs to have earned $1 million or less and have no more than 30 full-time employees.
• Research & Development tax credit. Supports businesses of all sizes in developing new processes or products, covering a broad range of qualified research activities. Unused credits may often be carried forward.
• Plug-in Electric Drive Vehicle Credit. A business may claim up to $7,500 per eligible vehicle purchased before 2023, subject to assembly, weight, and sales limits. Find out more on EV credit deductions.
• Empowerment Zone Employment Credit. Offers up to $3,000 per qualifying employee per year for businesses operating in designated empowerment zones.
• Retirement Plans Startup Costs Tax credit. This tax credit can help employers cover the initial costs of setting up a company retirement plan. Meeting certain criteria can reduce the amount of taxes your business owes. Read more about retirement plan tax credits.
• Employee Retention Credit. The Employee Retention Credit supported small businesses who needed to suspend or reduce operations because of COVID-19. Businesses affected were offered a refundable credit of up to $10,000 per full-time employee in 2020, with higher amounts for 2021.

You can find more information and a full list of tax incentives here and here.

Tax credits FAQs

What are Premium Tax credits?

The Premium Tax credit (PTC) is a refundable tax credit that helps individuals or families with the costs of their health insurance purchased through the Health Insurance Marketplace. These credits are exclusively for employees and are designed to aid individuals. Because it is refundable, any excess credit can reduce your tax liability or result in a refund.

Who qualifies for tax credits?

Different tax credits and deductions are available to different groups for different purposes. Individuals may qualify for credits such as the PTC, while businesses can access credits to support initiatives like environmental improvements, disabled access, pension plans, and more.

How do tax credits work?

While the rules vary by type, tax credits generally provide a dollar-for-dollar reduction of the taxes you owe, lowering your overall tax liability. Refundable credits can also result in a payment to you if the credit exceeds the amount of tax owed.

Keep on tops of tax credits to reduce costs

Tax laws are always evolving, and new schemes, behaviors or initiatives are regularly rewarded with tax incentives. Keeping on top of the ever-changing removal or inclusions of tax credit schemes is an essential part of maintaining a successful business. Make the most of Tax credits and get support for your business.