Tax Credits vs. Tax Deductions

As Benjamin Franklin said, “in this world, nothing is certain except death and taxes.” However, this doesn’t mean that you can’t be strategic in lowering your tax liability! Before that can happen, we need to first understand the ways in which tax liability can be lowered. Small-business tax credits and tax deductions are both ways for businesses to reduce their tax liability, but they work in different ways.

Tax deductions reduce the taxable income of a business, which in turn reduces the amount of income subject to taxation.

Example: The Section 179 deduction means that instead of depreciating an asset (equipment, vehicles, etc.) over its useful life, the business can immediately deduct the entire cost from its taxable income. This can significantly reduce the business’s tax liability in the current year.

On the other hand, Tax Credits directly reduce the amount of taxes owed dollar for dollar.

Example: The Off-Highway Fuel Tax Credit allows businesses to claim a credit for the excise taxes paid on certain types of fuel used in off-highway equipment. This credit is often associated with fuels used in activities such as landscaping, construction, and other off-road uses. Here are some key points about the Off-Highway Fuel Tax Credit:

1. Eligible Activities: The credit typically applies to fuels used in equipment that operates off the public highway. This includes machinery used in landscaping, construction, and other off-road activities.

2. Types of Fuel: credit is generally applicable to special fuels like diesel and kerosene, which are used in off-highway equipment. Gasoline may also be eligible in certain cases.

3. Claiming the Credit: To claim the Off-Highway Fuel Tax Credit, taxpayers usually need to file the appropriate forms with the Internal Revenue Service (IRS), such as Form 4136.

4. Documentation: Proper documentation is crucial. Taxpayers need to maintain records that support their claims, including details about the off-highway equipment, the amount of fuel used, and when it was used. List the gallons purchased during the tax year.

Tax credits provide a direct reduction in the amount of taxes owed, while tax deductions reduce the taxable income on which taxes are calculated. Both can be valuable tools for small businesses to manage their tax liabilities. It’s important for businesses to explore and take advantage of available credits and deductions to optimize their tax positions.

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