Research Credit

You don't have to be a major research facility to do research. Many inventors, for example, toil away in basement labs or small facilities. While most service providers like yourself do not have R&D costs, you never know what may happen to your business in the future.

If you undertake certain research activities and increase your expenditures for them year after year, you may qualify for a tax credit. The credit is up to 20% of increased research activities (increased costs this year compared with a base period that is usually the three preceding years). Alternatively, you may claim an alternative simplified credit, which works best for a business with little or no R&D spending in the previous years. This credit is 14% of the amount of current-year R&D spending that exceeds 50% of the average spent in the previous years.

The research credit is not limited to businesses that are creating new products for sale. The credit can be used for R&D to find new internal processes to help businesses run more efficiently and save money. And small businesses that meet gross receipts tests can use up to $250,000 of their research credit as an offset to the employer portion of Social Security taxes (obviously this won't benefit you unless you have employees).

Details of the research credit can be found in the instructions to Form 6765, Credit for Increasing Research Activities.

Disabled Access Credit

If, as a small business, you make capital improvements to make your premises more accessible to the handicapped, such as widening doorways or installing ramps for wheelchair accessibility, you may qualify for a credit of 50% of expenditures over $250 but not over $10,250. Thus, the top credit is $5,000.

If you claim the credit, you cannot depreciate these costs.

Details of the disabled access credit can be found in the instructions to Form 8826, Disabled Access Credit.

Employment-Related Credits

If you hire certain workers or provide certain benefits to your staff, there are special tax credits to help defray your cost. Since you don't have employees now but may in the future, here is a preview of the credits to remember:

• Work opportunity credit for hiring workers from certain designated groups, such as certain veterans, ex-felons, and vocational rehabilitation referrals. The basic credit amount is 40% of first-year wages up to $6,000, for a top credit of $2,400. However, different credit amounts apply to specific groups, such as summer youth and wounded veterans with service-related disabilities. To claim the credit, you must have the new employee sign Form 8850, Pre-Screening Notification and Certification Request for the Work Opportunity Credit, and submit it to your state workforce agency within 28 days of the first day of employment. Even if a new employee fits within a designated group, no credit can be claimed without timely filing the form. This credit is set to expire at the end of 2019, but could be extended by Congress.
• Empowerment zone employment credit for businesses located within a designated empowerment zone and that hire workers who reside within the zone. The credit is 20% of the first $15,000 of wages. This credit expired at the end of 2017, but could be extended by Congress.
• Employer differential wage payment credit for continuing the wages of a worker called to active duty. The credit, which applies only to a small business, is 20% of the differential that does not exceed $20,000.
• Employer credit for FICA on tips for food or beverage businesses. The credit applies to the employer portion of tips in excess of those treated as wages for purposes of satisfying the minimum wage provisions of the Fair Labor Standards Act, based on the old federal minimum wage rate of $5.15 per hour (even though the rate in effect in 2019 is $7.25 per hour). So, this employment credit is primarily for those in the food and beverage industry.
• Small employer health-care credit for paying at least 50% of the cost of employee health premiums. The credit is 50% of premiums, but only if coverage is purchased through a government Marketplace (with an exception for those with no options in the employer's location).
• Credit for small employer pension plan startup costs for starting a qualified retirement plan covering at least one employee who is not an owner or owner's spouse. The credit is 50% of administrative costs and employee-education expenses up to $1,000, for a top credit of $500. The credit may be claimed for three years, starting with the year in which the plan becomes effective, or the prior year.
• Credit for paid family and medical leave. If you aren't required by state or local law (federal law doesn't require it) to provide paid leave to employees but you choose to do so, you can take a tax credit, the amount of which depends on what percentage of normal wages you pay during up to 12 weeks per year for family and medical leave. For 2019, the credit only applies with respect to payments to employees who earned no more than $72,000 in 2018. The credit is set to expire at the end of 2019, but Congress could extend it.

Table 9.1 shows the tax form used for each of these credits.

Dependent Care Credit

If you hire someone to look after your child under age 13, or a disabled spouse or a disabled child of any age, so that you can go to work, you may claim a personal credit. The credit is a sliding percentage based on your adjusted gross income. The top percentage is 35%, but scaled back to 20% for adjusted gross income over $43,000. The percentage applies to eligible expenses up to $3,000 for one dependent and $6,000 for two or more dependents.

The credit applies to the following costs:

• Babysitter
• Day camp, including a specialty camp such as soccer or computers (but not a sleepaway camp)
• Day-care center
• Housekeeper (but only the portion of compensation allocated to dependent care)
• Private school for preschool and nursery
• Transportation, if supervised, such as a bus to day camp (but not your cost of driving to a day-care facility)

If you have help in your home who is not working for an agency, you probably become a household employer. This means you are responsible for employment taxes, which you report on Schedule H, Household Employment Taxes, which accompanies your Form 1040 or 1040-SR. If you are a household employer, you must obtain the worker's vital information, including his or her Social Security number, so you can properly report the employment taxes. If you use outside help, such as a day-care center, you'll need the center's employer identification number (EIN) for tax reporting purposes even though you won't owe any employment taxes in this case. No EIN is needed if you pay a tax-exempt charity for your dependent care.

Do you have to work outside the home while your child is being cared for within the home in order to take this credit? There is no specific IRS guidance on this question. However, if you need to pay someone to watch your child in your home so that you can work, even if it's in your residence, it would seem that you can take the credit if otherwise qualified to do so.

If your spouse works, too, and receives employer assistance for day-care costs, up to $5,000 of such reimbursement or payment is excludable. This exclusion must be coordinated with the credit. Reduce the amount of eligible expenses used in figuring the credit by the amount of the exclusion. Similarly, if your spouse contributes wages to a dependent care flexible spending account, expenses reimbursed from this account cannot be used in figuring the credit.

Find out more about the dependent care credit in the instructions to Form 2441, Dependent Care Expenses.

American Opportunity Credit

Going to college to earn a degree while you run your business? You may be entitled to a tax credit for the first four years of higher education. The credit is $2,500 (100% of the first $2,000 of qualified higher education costs, plus $25% of the next $2,000 of qualified higher education costs). The credit is allowed on a per-student basis, so if you and your spouse are each in college, the credit can be up to $5,000.

No tax credit can be claimed if your modified adjusted gross income (MAGI) exceeds a set limit. A partial credit is allowed if your MAGI is within the phase-out range; no credit is allowed if your MAGI exceeds this range. To give you an idea of what these limitations are, Table 9.2 shows the MAGI limits for 2019.

The credit applies only to tuition and related fees; it cannot be applied toward transportation, medical expenses, or personal living expenses. However, you can effectively prepay the credit to benefit on the current tax return as long as the payment is for an academic period that begins within the first three months of the year.

Learn more about the American opportunity credit in the instructions to Form 8863, Employment Credits.

Lifetime Learning Credit

There is no end to learning if you want to stay up on skills and developments impacting your business. Fortunately, you can claim a credit of up to $2,000, year in and year out, as long as you continue to take qualified education courses.

However, only $2,000 may be claimed on a return, so if you have a spouse or dependent who also qualifies for the credit, the family is limited to $2,000 on your return. The credit is nonrefundable, so you must have tax liability to offset it.

There are income limits on claiming the credit; they are not the same limits that apply for the American opportunity credit. If your income (technically modified adjusted gross income or MAGI) is below the limit, the full lifetime learning credit applies. If you fall within the phase-out range, a partial credit can be claimed; no credit applies if your MAGI exceeds the phase-out range. The limits can be adjusted annually for inflation. To give you an idea of what these limitations are, Table 9.3 shows the MAGI limits for 2019.

Learn more about the lifetime learning credit in the instructions to Form 8863, Employment Credits.

Earned Income Tax Credit (EITC)

This credit is designed to help low-income workers by providing tax assistance. The credit is fully refundable, which means it can be paid to an eligible person even if it is more than the taxes for the year.

Self-employed individuals may overlook this credit opportunity, believing it applies to company employees or only low-income people. However, in years in which self-employed individuals have a loss or only a little income, even people who think of themselves as middle class may nonetheless qualify for the credit.

A word of caution here. The IRS is looking closely at self-employed individuals who claim the EITC. It's checking to make sure income is reported properly and deductions claimed appropriately. Recently, there was a Tax Court case where the IRS challenged the income that a self-employed street vendor said she earned. She didn't have records of her earnings from the cash sale of socks, T-shirts, and hats (the court said she earned more than what she could prove) and she failed to take deductions to which she was entitled. The lesson here: you must have records to prove the amount of your income and can't forego deductions merely to boost an EITC.

The amount of the credit depends on the number of qualifying dependents, if any, and on adjusted gross income and earned income. Earned income is not limited to wages from employment; it also includes net earnings from self-employment. To claim the credit, you must file a tax return even if your income is below the threshold that requires a return to be filed.

Can you increase the earned income credit by not taking all the business deductions to which you are entitled so that you have larger net earnings from self-employment? It sounds tempting, but the IRS says no. First, a self-employed individual is required to report all business income and deduct all allowable business expenses. A self-employed person does not have the option of reporting only what is most beneficial. Second, the IRS is looking closely at self-employed individuals claiming the earned income credit and is checking that net earnings from self-employment is figured correctly (without omitting allowable deductions) and that the person really has net earnings from self-employment and isn't fabricating them just to take the earned income tax credit. Any tax return preparer whose client doesn't want to claim deductions or is fabricating income is advised by the IRS not to prepare the return; doing so can result in penalties on the preparer as well as the taxpayer. A paid preparer must submit a due diligence form when a client takes the credit, so you won't find a reputable return preparer willing to overlook the realities of your situation.

You can use the IRS's online EITC Assistant (at IRS.gov search for “EITC Assistant”) to determine whether you qualify for the credit. If you do qualify, be sure to file a tax return to claim the credit, even if your income is below the income threshold for filing a return. The IRS won't pay you the refund automatically; you have to request it by filing a return.

Learn more about the earned income tax credit in IRS Publication 596, Earned Income Credit.