While few people actually look forward to tax season, there is at least one silver living for many taxpayers: tax refunds. According to Internal Revenue Service (IRS) filing season statistics for the week ending April 23, 2021, the average tax refund is $2,870. That's not an insignificant amount by most people's standards, which leaves many small business owners wondering if they're entitled to an income tax refund.
Small business tax refunds aren't as common as refunds for individuals, but they're not unheard of. Here's what you need to know.
Most small businesses don't pay income taxes directly
Of the more than 25 million businesses in the U.S., more than 95% are pass-through businesses, including sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations. Unlike C corporations, which pay federal income taxes at the corporate level, a pass-through entity's profits “pass-through" to the owner or owners' individual tax returns, and the owners pay taxes rather than the business.
If you own a pass-through business and your estimated tax payments and tax withholding exceed the tax due on your return, you can receive a tax refund.
Only C corporations pay income taxes directly, so C corporations are the only businesses that can get a refund. And the business only gets an income tax refund if it paid more in estimated taxes than it owes.
Businesses may qualify for payroll tax refunds
Of course, income taxes aren't the only type of taxes businesses pay. If your business has employees, you're required to withhold and pay payroll taxes on employee salaries and wages.
In most cases, you withhold payroll taxes every pay period, make payroll tax deposits on either a monthly or semi-weekly basis, and file payroll tax returns at the end of each quarter. If you calculate your payroll tax deposits correctly, the business usually doesn't owe any additional tax or have an overpayment to be refunded.
However, there are a few situations that can result in a payroll tax refund.
Research and development tax credit
The research and development (R&D) tax credit is a federal income tax credit designed to encourage businesses to perform qualified research in the U.S. In most cases, businesses that qualify for the credit use it to offset federal and state income taxes. However, new and small businesses with little or no federal income tax liability can also use the R&D credit to offset up to $250,000 of the employer's share of Social Security taxes for up to five years.
To qualify for the R&D payroll tax offset, the company must have:
- Five or fewer years of gross receipts, and
- Less than $5 million in gross receipts in the year the company claims the credit
To apply the R&D credit to your payroll tax liability, you need to complete Form 8974 and attach it to your payroll tax return.
Employee retention credit
The Coronavirus Aid, Relief, and Economic Security (CARES) Act created a new payroll tax credit for employers who paid wages and health benefits for employees while business operations were fully or partially suspended during the COVID-19 pandemic.
The employee retention credit is worth up to $5,000 per employee in 2020 and up to $7,000 per employee per quarter in 2021. Since it's a refundable credit, small businesses can get a cash refund if their available credit exceeds the amount of employment taxes the business owes.
To claim the credit, small businesses can reduce their employment tax deposits. Small employers can even get an advance on the credit by filing Form 7200.
Receiving a tax refund may seem like a windfall, but in most cases, it simply means you overpaid your estimated taxes. You can put that money to better use in your business throughout the year by working with a tax professional to accurately calculate your tax liability and paying only what you expect to owe—no more, no less.
