Key Deductions and Credits Explained for Small Business Taxes

When it comes to reducing tax liability, small business owners have two primary tools at their disposal: tax deductions and tax credits. While both help lower taxes, they function in very different ways. Understanding how each works—and which is more beneficial in different situations—can maximize your tax savings and keep your business financially healthy.

In this guide, we’ll break down tax deductions vs. tax credits, explore clean energy tax incentives, and discuss how to claim them properly while staying IRS-compliant.

What Are Tax Deductions and Tax Credits?

Tax Deductions

A tax deduction reduces the amount of income that is subject to taxation. This means your total taxable income is lowered, which results in a lower tax bill.

For example, if your business earns $100,000 and you have $20,000 in deductions, your taxable income is reduced to $80,000—meaning you only pay taxes on that amount.

Tax Credits

A tax credit is a dollar-for-dollar reduction of the taxes owed. Unlike deductions, which reduce taxable income, credits directly reduce the amount of tax you owe.

For example, if your tax bill is $10,000 and you qualify for a $2,500 tax credit, you only owe $7,500 in taxes.

✅ Key Difference:

• Deductions lower taxable income.
• Credits directly reduce tax liability.

Clean Energy & Manufacturing Tax Credits

With the Biden Administration’s focus on clean energy incentives, several new and expanded tax credits are now available to small businesses. These credits help companies invest in green technology, electric vehicles, and energy-efficient manufacturing.

1. Clean Vehicle Tax Credits

Businesses purchasing electric vehicles (EVs) for commercial use may qualify for tax credits of up to $7,500 per vehicle.

📌 Requirements:

• The business must purchase the vehicle (not a personal purchase) and the vehicle should be used 100% for business purposes.
  • If you plan to use it for personal reasons, similar credits are available for personal use vehicles.
• The vehicle must meet IRS and Department of Energy regulations on battery capacity and final assembly location.
• The credit amount depends on vehicle weight, battery size, and use case.

2. Manufacturing Tax Credits for Clean Energy

Businesses involved in clean energy production or manufacturing components for renewable energy (e.g., solar panels, wind turbines, EV batteries) may qualify for:

• Investment tax credits (ITC) for energy-efficient upgrades.
• Production tax credits (PTC) for manufacturing renewable energy equipment.

These credits are designed to reduce the cost of adopting clean energy solutions while keeping U.S. manufacturing competitive.

How Do Tax Deductions Work?

A business can deduct ordinary and necessary expenses related to operations, including:

✅ Common Business Deductions:

• Rent & Utilities: Office rent, internet, electricity
• Payroll & Benefits: Wages, health insurance, 401(k) contributions
• Marketing & Advertising: Social media ads, website costs
• Business Travel & Meals: 50% deduction on meals, full deduction on travel
• Office Supplies & Equipment: Computers, software, office furniture
• Depreciation: Vehicles, real estate, large equipment

Example:
A business earns $150,000 in revenue and has $50,000 in deductions. Instead of being taxed on $150,000, they are taxed on $100,000, saving thousands in taxes.

How Do Tax Credits Work?

Since credits directly reduce tax liability, they can provide larger savings than deductions in some cases.

✅ Common Small Business Tax Credits:

• Small Business Health Care Tax Credit: Helps offset the cost of providing employee health insurance.
• Work Opportunity Tax Credit (WOTC): Credit for hiring employees from underrepresented groups.
• EV Tax Credits: Credit for purchasing electric or hybrid business vehicles.
• R&D Tax Credit: Helps businesses recover costs for research and innovation.

Example:
A business owes $15,000 in taxes but qualifies for a $4,000 tax credit. Instead of paying $15,000, they only owe $11,000.

Which Is Better: Tax Deductions or Tax Credits?

📌 General Rule of Thumb:

• If your taxable income is high, deductions provide long-term savings.
• If your tax liability is high, tax credits immediately reduce what you owe.

How to Claim Tax Deductions and Credits

For Tax Deductions:

1. Keep accurate records of expenses (receipts, invoices).
2. Categorize expenses properly using bookkeeping software.
3. Report deductions on your business tax return (Form 1120, 1120S, or Schedule C).
4. Depreciate large assets over time if necessary.

For Tax Credits:

1. Verify eligibility (some credits require pre-approval).
2. Complete the correct IRS forms.
3. Include documentation supporting your claim.

LedgerFi Insider Pro Tip: IRS Compliance & Audit Triggers

The IRS carefully reviews deductions and credits to prevent fraudulent claims. Some red flags that could trigger an audit include:

🚨 Excessive Meals & Entertainment Deductions

• The IRS typically flags business meal deductions if they seem too high compared to revenue.
• If meals exceed 2-3% of total expenses, it could raise suspicion.

🚨 Negative Net Income in More than 3 of the last 5 Tax Years

• Regardless of business structure, if a business repeatedly reports a negative net income, the IRS may request justification and supporting records for the losses.

🚨 Claiming Business Use of a Personal Vehicle

• The IRS scrutinizes vehicle deductions, especially if the business reports 100% business use of a car.
• Best Practice: Keep a mileage log/app and business-related receipts.
  • If you use the vehicle for personal use, you’ll need to report the total miles you drove as well as the mileage for business purposes.

🚨 High Home Office Deduction Claims

• Home office deductions must be for exclusive business use.
• Common red flag: Deducting large portions of a mortgage or rent without clear justification.
  • Mortgage payments are not deductible towards home office expenses; only the mortgage interests paid on the loan.

• How to Stay Compliant:
  ✔️ Keep detailed records of all deductions and credits.
  ✔️ Work with a bookkeeper or tax professional to ensure proper filings.
  ✔️ Don’t inflate deductions or credits—the IRS has strict guidelines.
  

  Good Bookkeeping is Key to Maximizing Deductions and Credits

Tax deductions and credits can significantly reduce your business’s tax burden, but proper bookkeeping is essential to track expenses and ensure compliance. Year-round tax planning is critical so you know where you stand before tax season arrives.

At LedgerFi, we specialize in small business tax strategies, helping you maximize deductions, claim eligible credits, and stay IRS-compliant.

📞 Need help optimizing your tax savings? Contact LedgerFi today to make sure you’re not leaving money on the table.