What is the Tax Benefit?
Tax Benefits refers to the credit that a business receives on its tax liability for being in compliance with a norm proposed by the government. The benefit is either credited back to the business after paying its regular taxation amount or it is deducted when paying the tax liability in the first place.
A business is required to pay taxes to the government on the income which generates in the fiscal year. The rate of taxes varies depending on the country and industry in which the business is being done. A business can use specific provisions of the country’s tax legislation to reduce the said tax payment to the government.
Utilizing the tax benefit is essential to put the funds available to the best utilization. The amount of tax that is saved can be used for further business expansion. It is to be noticed here, that the tax-saving has to abide by the terms that are mentioned in the tax legislation else it might lead to evasion of tax which has legal implications attached to it.
Tax Benefit Forms
Tax benefits may be obtained in the following forms.
#1 – Tax Exemption
In this scenario, the entire income earned will be non-taxable. It happens because of the unique condition through which the income is earned. For example, to uplift the economic condition of a particular under-developed city, the government may exempt the income from taxation for 3 years if any business works out from there. In that scenario, let’s say if the business earns a total income of $40,000, the entire amount will be exempt from taxation, and tax payable will be nil.
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#2 – Tax Deduction
Here, a portion of the income will be reduced when calculating the income that is amenable to taxation. It could be because of certain special expenditures that the business might have done or certain capital assets that the business might have purchased, which the government intends to promote for greater use. For example, the total income of the firm might be $115,000, and there is a special tax deduction of 50% of the value if there’s a purchase of Govt. manufactured machinery, licensed as environment-friendly. Let’s say the cost of the machinery, in this case, is $10,000. Now, the business will let a benefit of 50% of the amount expended on this machinery, which comes to $5000. Therefore, the total income that is taxable will be $115,000-$5000 = $110,000.
#3 – Tax Credit
In this case, there is no difference in the income that is being taxed. Instead, there is a rebate on the taxation that is paid. It might arise because of the tax credit from the previous or due to the fulfillment of other special provisions. For example, a business earns a total of $150,000 on which it is liable to pay tax at 20%. The tax payable amount will come to $30,000. Now, let’s say there was a pending taxation suit from the last year whose decision took place in the current year. Last year, an excess of taxation of $4,000 was paid. So, this year the business will get the credit. Hence, the actual taxation payable will come to $30,000 less $4000 equal to $26,000.
Example of Tax Benefit
- Business XY is into the business of providing readymade garments for men. For the financial year 2019, the gross revenue totaled $1,500,000, whereas the total expenses accrued to $650,000. The net revenue, therefore, is $850,000. The tax slab for all the businesses is at a flat 20%. However, the business also involves itself in social-welfare activities. It built a community home worth $20,000 and gave donations to sick homes worth $35,000. Now, the government has given a tax deduction of 50% on donations and 75% on expenditures for the social community.
- So, in this case, out of total revenue of $850,000, which should be have been originally taxable, the business will get the benefit from the donations and the community homes it has built. The deduction on donations will be 50% of $35,000, which is $17,500, and the deduction on community home is 75% of $20,000, which is $15,000.
- Therefore, the income that will be taxed will be $850,000, less $17,500 less $15,000, which is equal to $817,500. A 20% charge on this amount would mean total taxation of $163,500. It is to be noted, though, that the expenditure on community home and donations must fall under the approved list with the government. It is done so that the businesses may not come up with fraudulent organizations of their own to evade taxes.
Tax Benefits of Health Insurance
Almost all countries promote the concept of providing for health insurance either for oneself or employees of the business. The amount that is expended on the premium for such health insurance is available as deductions in the calculation of taxable income. The amount that becomes eligible as deduction could be an absolute number, or it could be an allowable percentage limit.
For example – The premium on health insurance of the employees may be allowable as deductions from taxable income to the maximum of $10,000 or 10% of the gross taxable income before such expenses whichever is lower. So if the gross taxable amount is $90,000 and the expenses on medical insurance are $12,000, the amount that will be eligible for deduction will be a flat $10,000 or 10% of $90,000, which is $9,000. The latter will become the eligible amount because it is lower, so the final taxable income will be $90,000, less $9000 equal to $81,000.
A business needs to plan the expense that will help it to reduce the tax burden, either in the form of exemptions or deductions. Smart planning and the use of specialized services where the internal management is lacking the knowledge helps utilize the best procedures available and thereby make better use of the provisions that are being offered by the government. Apart from saving funds, it provides an excellent message to the stakeholders that the management is proactive in planning, and it also creates a cordial relationship with the regulators and the government.
This article has been a guide to what is tax benefit and its meaning. Here we discuss the tax benefits of health insurance along with an example and forms. You may learn more about financing from the following articles –