Finance

5 Overlooked Tax Deductions for Small Business Owners

In an effort to maximize income and limit taxes paid, business owners and managers need to know every expense they can legally deduct.

In an effort to maximize income and limit taxes paid, business owners and managers need to know every expense they can legally deduct.

Below are some often overlooked tax deductions.

1. Petty Cash

Petty cash is used to pay for the small, incidental expenses that often arise in the operation of a business. It is very important to have a system for keeping up with these expenses, since they can add up over time to more than many business owners expect.

It is always advisable to have a written petty cash policy to ensure that cash on hand is not wasted. By having a policy, employees know what petty cash purchases are approved and which expenditures should be paid for with a company check after a more formal approval process.

Keeping a log book to document these small cash expenditures is always a good idea. Whether it is paying for pizza for a team lunch or the donuts for a morning meeting, petty cash is a necessary evil. Don’t forget to keep receipts and write down the purpose. Without this documentation, the IRS can disavow an expense and allow it to be taxed.

Be sure to write down the details of the transaction. The time, amount, date and an exact description of the product or service purchased are necessary just in case there is an IRS audit.

2. Carryover Deductions and Credits

The limits the IRS imposes on tax exemptions, credits and deductions often makes it impossible to deduct the full amount during one tax year. In cases where these amounts exceed annual limits, then business owners can carryover the excess writeoffs to future tax returns filed.

Depending on the specifics for that year, tax deductions and credits can be claimed on multiple tax returns to offset taxable income. While many tax breaks are only available for one year, others are claimed over a period of two or three years.

One example of a loss that can be used over more than one year is capital losses. For example, if you buy and sell stock taking a loss of over $3000, then the excess over the $3000 limit can be claimed in the future.

Other examples of losses that can be carried forward and claimed on future tax returns are charitable contributions, net operating losses and business startup costs which all have limits imposed on how much can be written off annually. As tempting as it might be to use charitable contributions to offset a majority of your income, the IRS only allows a business to write off 50% of its income. Fortunately, the remainder can be carried into future years.

3. Miscellaneous Business Expenses

Miscellaneous expenses represent necessary costs required to run a business. These costs don’t fit neatly into specific categories on a tax return, earning the designation as miscellaneous expenses. Since there are often deductible limits on many of these items, it is important to review them annually as they can change from one year to the next.

A few of the common miscellaneous expenses that are allowable are bank fees, club dues, professional association memeberships, credit card fees, and professional subscriptions for publications business related topics. It is far too easy to mentally discount the sizable total amount of these expenses when business owners don’t have a system for tracking them.

Since the amount can be larger than expected, it is highly recommended that the receipts and invoices be saved throughout the year. Smart business owners don’t pay taxes on income that was used to pay expenses.

4. Bad Debt

There are very specific rules about the definition of bad debt and whether it can be legally deducted as a tax writeoff. Several factors must be considered and followed so that this deduction will standup under the scrutiny of the IRS if necessary.

Obviously, a bad debt must be backed up in writing. A loan made without any documentation should not be counted as a bad debt for tax purposes.

An important distinction that must be considered when determining whether an unpaid loan can be claimed as a bad debt loss is to decide whether a loan is a non-business loan or a business loan. If a bad loan debt arises as the result of conducting regular business, then it is considered to be an ordinary loss for tax accounting purposes and can be completely deducted. A partial loss can also be deducted in this type of situation.

One big exception to this rule of claiming a bad debt loss is linked to the type of accounting method a business employs. Small businesses either use a cash method or an acrual method of accounting. Unfortunately, businesses that operate with a cash method of accounting can’t claim a bad debt since the debt is not recognized as having a tax basis. Conversely, businesses that use an accrual basis for accounting purposes can deduct a bad debt from their taxes.

The tax law changes constantly. Obtaining professional assistance to determine whether a bad debt is deductible is always recommended.

5. Research Expenses

Like so many tax related deductibles, deciding how to write-off research costs is complicated and depends on specific data. These costs can be expensed and taken as a tax deduction or they can be amortized. Research tax credits also offer a viable way to offset taxes.

The important thing to remember is that research is typically considered a capital expense since these efforts are associated with increasing business value. This is why many capital expenses are amortized like depreciation and written off over a period of time.

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