Business Tax Credits: How They Work, and Example

What are tax credits for businesses? The simple answer is they’re reductions in tax liability, decreasing the amount of tax a company owes. However, the full story is more complex, including that they differ significantly from deductions and can be refundable or non-refundable, depending on the jurisdiction.

We’ve created this article to more comprehensively explain how business tax credits work. We’ll also be outlining some examples alongside highlighting how they impact wider tax strategy and compliance.

What Are Business Tax Credits?

Business tax credits are incentives tax authorities offer to encourage businesses to behave or invest in alignment with government goals. For instance, adopting certain employment policies or meeting sustainability targets. Unlike tax deductions that lower taxable income levels, credits are applied to reduce the amount of tax owed. Some tax credits will generate a refund if the tax liability is zero, while others only reduce tax obligations until they reach zero.

Types of Tax Credits for Businesses

The types of business tax credits governments provide can vary between jurisdictions. In general, though, they will be grouped into categories that reflect the incentivized behavior or activities they would like to encourage. The most common of these categories are employment-based, investment-based, and those focused on the environment and innovation.

Employment-Based Credits

These tax credits often reward companies that offer enhanced staff benefits or hire individuals from specific demographic groups. For instance, the Work Opportunity Tax Credit (WOTC) in the U.S. supports the employment of veterans and other historically underrepresented groups. Certain eligibility criteria—like minimum working hours—must be met, with credits issued as a percentage of wages paid.

Investment-Based Credits

These credits encourage companies to invest significant capital in physical infrastructure, property rehabilitation, real estate, and equipment, among other elements. For instance, rehabilitation credits help fund the restoration of certified historic properties, while capital investment credit might finance manufacturing facilities.

Research and Development Credits

Research and development (R&D) credits are incentives for stimulating innovation, helping to reduce the costs of new product development or process improvements. While there will usually be eligibility requirements around proving R&D measures are innovative in nature, both startups and large corporations are common recipients.

Energy and Sustainability Credits

As pressure to meet environmental goals rises, governments are increasingly offering energy and sustainability credits to reward businesses for proactive measures. Common focuses for credits include adopting renewable energy, investing in electric vehicles, and implementing wider sustainability protocols. However, the availability and eligibility requirements of these credits vary regionally.

What Are Tax Credits for Small Businesses?

Small businesses often have access to certain types of credits that are easier to qualify for, as they’re aimed at supporting small business growth. Credits are usually subject to maximum size thresholds, such as the number of employees or level of revenue. Common small enterprise credit examples include those for providing health insurance, training programs, and accessibility improvements.

How to Qualify for Business Tax Credits

Qualifying for tax credits begins with researching which credits align with the business’ sector, size, or activities. From here, it’s important to assess each credit program’s requirements, including the structure of the organization and its compliance with mandated standards. Companies can then gather documentation supporting their claims, such as payroll data or investment receipts. Indeed, it is essential to keep accurate records year-round to prove ongoing alignment with eligibility requirements.

How Business Tax Credits Work in Practice

Tax credits are typically applied during tax filing against the calculated tax owed by a business. In most cases, the non-refundable credits—which can only reduce a tax bill to zero— are applied first, and then any relevant refundable credits are applied afterward, potentially resulting in a payment. In some jurisdictions, tax authorities allow the carryforward or carryback of any unused credits, meaning companies can gain value against future or prior filings.

Real-World Example of a Business Tax Credit

A good illustrative example is how a small tech startup could gain research tax credits. They perform eligibility assessments, calculate the costs of their applicable research, and identify relevant credits to apply for. They’ll then calculate the amount of credit they qualify for, based on the tax authority’s percentage stipulations—in this instance, $25,000 of credit. The company also consults with a tax expert, who advises on ongoing regulatory compliance measures and recommends record-keeping protocols to mitigate audits. They’ll then file this claim with their tax return, providing development logs, invoices, and payroll data as supporting evidence. The tax authority approves the credit, reducing the firm’s tax bill from $30,000 to $5000.

Benefits and Limitations of Tax Credits

There are several compelling benefits of tax credits. Beyond the obvious reduction in tax liability, credits can also incentivize business growth and boost capital through potential refunds. There are also limitations, though. They can be complex to calculate and apply and eligibility requirements can be strict. Additionally, credit legislation can change from year to year, alongside those related to other financial protocols, such as transfer pricing tax strategies. As a result, companies should collaborate regularly with experienced tax professionals to identify opportunities and plan strategically.

Role of Corporate Tax Services in Managing Credits

Tax credit processes can be complex. Corporate tax services play a vital role in helping companies navigate challenges, utilizing their knowledge and experience to identify applicable credits. They provide a range of services, including assessing eligibility, preparing supporting documentation, and defending companies during audits. International tax consultants are particularly vital for businesses with global operations, as accessing credits may involve managing overlapping schemes or addressing complex legislation.

Interaction with Other Tax Strategies

Tax credits are often most impactful when part of a broader tax strategy that also utilizes mechanisms like deductions or deferrals to maximize advantages. After all, proper integration of credits alongside these elements can enhance liquidity and support growth. Credits also play a role in international tax planning, with companies making jurisdiction selections partially on the tax resources available. Nevertheless, businesses must avoid over-reliance on or misclassification of credit eligibility, as this can lead to compliance issues and even lost value.

FAQs

What are tax credits for businesses?

They’re reductions in the amount of tax owed by businesses, provided as incentives for meeting specific criteria or engaging in eligible activities.

What are tax credits for small businesses?

Incentives for businesses under a defined size or revenue threshold, intended to support employment, innovation, or investment.

Is a tax credit better than a deduction?

Usually, as credits reduce actual tax owed, while deductions reduce taxable income.

Can unused tax credits be carried forward?

In some jurisdictions certain credits may be carried forward or back to offset other years’ taxes.

Do I need a consultant to apply for business tax credits?

While not mandatory, professional assistance is recommended to navigate eligibility criteria and maximize available benefits.

References

IRS. (2025, May 8). Work Opportunity Tax Credit. IRS. https://www.irs.gov/businesses/small-businesses-self-employed/work-opportunity-tax-credit

UK Government. (2024, May 8). Check if you can claim Research & Development (R&D) tax relief. UK Government. https://www.gov.uk/guidance/corporation-tax-research-and-development-rd-relief 

Energy Star. (2022, December 30). Tax Credit Information. Energy Star. https://www.energystar.gov/about/federal-tax-credits/tax-credit-information