John Sculley III, who was chairman of PepsiCo until he became CEO of Apple Inc. for more than a decade, he said that “timing is everything.” He was probably referring to business moves, but the sentiment applies equally to tax write-offs. Due to various limitations on certain deductions and tax credits, you may not be able to use the full amount of the write-off in the year in which it is incurred. Instead, the unused amount can be carried forward and used in future years (or back in limited cases). Making full use of the write-offs you’re entitled to means keeping a close eye on these transfers. Here are some of the most common transfers small business owners should look for and the records you should keep.
General business credit
Business lines of credit—and there are more than 2 dozen of them—all have their own eligibility rules, including the maximum credit amount. However, these credits are subject to an overall limitation called general business credit. If total credits exceed the limit, the excess is carried back one year and then for up to 20 years.
Track each year in which excess general business credit is incurred and each year in which a carryover is used. This is because there is an ordering rule that allows a current deduction first for any carryovers in that year (oldest first), second the business credits for the current year, and thirdly any carryovers in that year (oldest first).
Home office discount
If you have a home office and don’t use it Simplified IRS option but instead of deducting your actual expenses for business use of your home, the deduction cannot exceed the gross income from the business use of the home less business expenses (“gross income test”). Any unused amount can be carried forward and used in a future year to the extent of the gross income check. This is true even if you move to a new home. Transfers can be used indefinitely, subject to gross income control.
If your business expenses exceed your income, you definitely have a financial loss, and you probably also have a tax law (limitations on deductions can mean there’s a difference between a loss on your books and a tax loss). Let’s say you own a business that operates as a pass-through entity—a sole proprietorship, partnership, limited liability company, or S corporation—and a loss is passed through to you. Your current deduction is limited by a tax rule called the unincorporated loss excess limitation. An excess business loss is the amount by which the total deductions attributable to all your trades or businesses exceed your total gross income and profits attributable to those trades or businesses plus a threshold amount adjusted annually for inflation (see . instructions for form 461).
Any loss in excess of this limit becomes part of a net operating loss (NOL). The NOL deduction is calculated using some adjustments. The NOL can be carried forward indefinitely to offset up to 80% of taxable income (farm businesses also have a 2-year carryback). If there are multi-year NOL carryforwards, use them in the order in which they occurred (ie, oldest are used first).
You must attach a statement to your tax return that shows all the important information about the NOL. The return should include a calculation showing how you calculated the NOL deduction. If you deduct more than one NOL in the same year due to multiple carryovers, your return must cover each of them.
If you are purchasing certain property for your business and cannot fully expense the cost using first-year expenses (deduction 179), bonus depreciation, or a safe harbor created by the IRS (all of which are explained in IRS Publication 946), you are left with deducting an annual depreciation allowance. The depreciation period is a fixed number of years set by law and depends on the type of property. For example, most business equipment and machinery are 5- or 7-year real estate, while commercial real estate has a 39-year depreciation period.
It is necessary to keep track of annual depreciation so that you can:
- Keep claiming these deductions until they are used up
- Figure recovery of depreciation where required
This list is not exclusive, but some other metaphors you may come across are related to:
- Capital losses
- Charitable contributions
- Investment interest
- Losses of passive activity
- Prepaid expenses
When it comes to transportation, there is bad news and good news. The bad news is that it’s up to you to track them. the IRS does not do this for you. The good news is that your tax preparation software (assuming you use the same year over year) or your CPA or other tax professional will automatically keep the required records of the transfers. Don’t let poor record keeping keep you from claiming every expungement you’re entitled to.
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