So … When Can I Deduct a Business Loss?

If you think a business loss can always be deducted on your income tax return, you might be in for a surprise. Beware that there are rules that limit this deduction. The bottom line is that the IRS insists taxpayers risk their own money in an enterprise when claiming a tax-deductible loss. Consider the following limits as you prepare to deduct a loss.

At-Risk Limit

At-risk limitations apply to individual sole proprietors, partners, and shareholders in S corporations. If your business has more allowable expenses than income, the excess money spent is limited from the deduction on your tax return. You must be losing your own money or borrowed funds that you are personally liable to repay.

Borrowing money from a friend or family member may result in business funds for which you are not at risk. To qualify as being at risk, any loan should have a formal promissory note that bears interest and has a specified due date for repayment.

Keep track of how much money you invest in your business. If you do have a deductible loss, it reduces the amount you still have at risk. Any money or other property you withdraw from your company for personal use decreases your at-risk amount.

A loss of other people’s money that is denied as a tax deduction carries over to subsequent years. That carryover loss can be deducted against future year profits.

Shareholder Basis Limit

Business owners of S corporations are confronted by an even greater burden known as the basis limitation.

Meticulous records for each shareholder are necessary to account for cash and property contributed to an S corporation. Added to these amounts is a shareholder’s proportional share of profit. The sum comprises the shareholder’s stock basis in the S corporation. But some of the profit is typically distributed to shareholders. These distributions reduce the stock basis.

Additionally, corporate profit for tax purposes is not profit in your bookkeeping. Some expenses paid by a business are not deductible on the income tax return. Nondeductible expenses reduce shareholder basis, just like distributions of profit.

Moreover, certain types of income and deductions are not included in an S corporation’s profit. Capital gains, for instance, retain their distinctive character and pass through to S corporation shareholders as a category of income that’s different from business profit. A Section 179 tax deduction is also separate from other business expenses. These and more are additions or subtractions from a shareholder basis.

Lastly, shareholders may loan money to their S corporations and establish “loan basis” as a different figure from stock basis. But loans are only valid when they bear interest. A minimal amount of interest must be calculated, even if it’s not being paid every year.

The upshot: losses triggering negative amounts of basis are nondeductible. This typically arises from borrowing to acquire fixed assets, such as machinery or equipment. When the cost of these items is rapidly deducted as depreciation, the business has a loss. But the loan still has an unpaid balance. The loss reduces shareholder basis.

Keep in mind that nondeductible losses carry over to future years. They are deducted when basis is restored by a shareholder’s cash investments or loans to the company or by future profit.

Discover the Secrets to Surviving Income Tax Reporting

Many business owners are concerned about paying their income tax liability, but far fewer are capable of accurately calculating their tax obligation. Although the burden of tax return preparation is best outsourced to professional accountants, entrepreneurs can take steps to ensure timely and thorough income tax reporting. After all, tax professionals can only know the financial details about your business that you convey to them.

Start by choosing a suitable system for maintaining your business records. This untangles the taxable events of an entire year. The use of technology is typically beneficial. Even a simple electronic spreadsheet of business revenue and expenses permits a computer to perform mathematical functions and minimize human error.

And this is far superior to a haphazard pile of receipts. The spreadsheet provides totals for annual revenue collected and amounts spent on each category of business expense.

Accounting software is even better because it balances revenue and expenses to cash sources, such as bank accounts and credit cards. This double-entry accounting system ensures you haven’t missed recording any transactions. However, professional assistance in knowing how double-entry bookkeeping works is crucial to obtaining accurate output from accounting software.

If you do have regular bookkeeping procedures, aim to examine and understand all the components that make up your financial statements. Go over any uncertainties with your bookkeeper to tie up loose ends.

Lastly, be at the starting line with your accountant to finish your tax return on time, obtain tax-related bookkeeping adjustments, and get suggestions for improvement in the year ahead.

Get Your 2019 Accounting Ready for Tax Time

Running a business entails so much work selling, delivering, and planning that precise financial tracking throughout the year is challenging. Despite having a sound bookkeeping system in place to facilitate judicious financial records, the process is unlikely to proceed without a hitch.

Most mistakes are a consequence of incomplete information when bookkeeping data entry is performed. Lost receipts or forgotten details about specific purchases are omissions any busy entrepreneur can experience. But the start of a new calendar year is the time to locate missing information and clean up the books before presenting them to your accountant for income tax return preparation.

Repair Financial Balances

Start with the business balance sheet. This report shows all the assets and liabilities of your business. These numbers correlate with the vital tax-related amounts of business profit and owner capital. Business owners can easily verify figures on the balance sheet for accounts with financial institutions by reconciling them to their account statements. Reconciling bank accounts and credit cards are standard bookkeeping procedures.

A frequently neglected area is fixed assets, such as machinery, equipment, buildings, and leasehold improvements to rented space. Not all amounts spent on equipment or a building should be added as fixed assets on the balance sheet. Some costs are low enough to expense as small tools or repairs. Your accountant can provide the income tax standards regarding which expenditures to categorize as fixed assets. Providing your bookkeeper with these rules permits easy year-end reclassification of amounts that might have earlier been misclassified as fixed assets.

Other areas to diagnose are accrued tax liabilities and long-term loans. Such liabilities as payroll taxes and sales tax should match remittances your business is scheduled to make. They are verifiable against records in other systems, such as payroll summary reports and sales reports.

Loan payments during the year include both interest and principal repayments. A loan history statement from the lender ensures all interest is deducted as an expense, with the remainder of payments applying to a loan account on the balance sheet.

Examine More than Profit

On the business income statement, make sure the correct amounts have been posted for payroll. One expense category should report total gross wages, not merely the sum of net paychecks. A different account covers the business part of payroll taxes. This excludes taxes withheld from employee pay, which are simply part of the gross wages.

Conduct a general cleanup of accounts. Combine accounts that duplicate the same expense category using slightly different names. Don’t have too much labeled as simply “miscellaneous” expenses. Determine the correct classifications for any entries in so-called suspense accounts with names such as “Ask Later.”

You should also provide your bookkeeper with information on any business expenses paid with personal money. These are recorded as if the business had paid for them directly.

Overall, make sure to identify and confirm the validity of every number on financial statements. Some accounts may have been created during the year for expediency pending more detailed information. Explanations to the bookkeeper about unclear transactions are a responsibility of the business owner. In other words, don’t leave your tax accountant wondering about mystery figures.

Start the New Year Right with a Review of Bank Reconciliation

The most important step an entrepreneur can take to ensure all revenue and expenses are recorded in the books is a reconciliation of the bookkeeping to bank records. Unexplained discrepancies between the cash balance on the books and the bank statements are a by-product of missing or inaccurate financial information. The result is questionable recorded profit.

After the prior year’s end, it is ideal to uncover legitimate reasons for the books to differ from a bank statement. A bank account on the balance sheet of your business from last month may show a different amount than last month’s bank statement. Some checks you’ve written may be outstanding, or deposits on the final day of the month might have been unprocessed when the bank statement was produced.

The reconciliation process locates previously missing transactions, such as bank charges, electronic remittances, and unrecorded deposits. But a business owner must scrutinize the reconciliation report to determine if further adjustments are needed.

Checks written long ago that have not yet cleared your bank account are known as stale checks. Any of these outstanding checks from more than a year ago should be removed from the business books with a journal entry dated in the current year. The business has ultimately not incurred these costs since the money never left the bank account.

The only deposits that should be missing from the bank statement are those you made at the end of the statement period. Older unreconciled deposits are indicative of errors or duplications and should be investigated.

Maintaining these current reconciliations will put you in a good position to start the year on solid financial footing.

Small-Business Financial Resolutions for the New Year

The approach of a new year inspires hopeful thoughts for the future. Topping the list is an eagerness for financial security, but achieving this requires more than abstract desire. Financial goals are only attainable when one constructs a workable design for the future. Despite uncertainties that may arise, commitment to a few indispensable actions can help your business thrive in the year ahead.

Start Early on Taxes

Perhaps the best protection against uncertainty is starting early on tax return completion. Tax season starts right after the middle of January. By the end of January, you have no excuses for not knowing prior year results.

A commitment to organized financial statements assures that tax return preparation work proceeds smoothly and is completed early.

Your accountant will likely have some annual bookkeeping adjustments for tax purposes. You only need to have the books in order that summarize ordinary day-to-day results of business operations. You should be aware of key elements such as total revenue, totals paid for each business expense category, and year-end asset and liability balances. Make sure your bookkeeper has enough information to reconcile the books to financial institution statements for bank accounts, credit cards, and loans.

Tax returns have deadlines. Long before the due date of your income tax return, you want to know the amount of any tax you owe.

Commit to Financial Evaluations

Maintaining reliable financial records throughout the year allows you to monitor business performance. Conducting regular self-analysis assures you’re on track for achieving your objectives. Be sure to plan for devoting time next year to recurring examination of business financial statements. This is the only path to quickly resolving any omissions or errors.

If you’re not sure how to interpret the business financial statements, professional accounting help is all you need. An accountant can summarize income from various products or services as well as describe where the money is being spent along with spending trends. Armed with this information, you can make optimal decisions about directing your time and other resources to maximize profit.

Reduce Business Expenses

A surefire way to increase business profit next year is to reduce expenses. Revenue can remain unchanged while the bottom line improves simply from lower costs. Resolving to save a fixed amount is too abstract. The better resolution is determining a precise expenditure target.

A cost-reduction goal may seem small, but it adds up over the course of a full year. Lowering a recurring monthly expense by $20 puts an extra $240 in your pocket. Since $20 isn’t much, select a few categories for this savings. Reducing the monthly cost for insurance, telephone, and internet by $20 each delivers a $720 annual savings. This means a lot to a small company. Even a large enterprise strives for this amount of profit increase, because it’s enough for a loan payment on a large amount for expansion or upgrades.

Completing your tax return early, committing to regularly scheduled financial statement examination, and continuously checking up on specific cost-reduction goals are resolutions to keep for success throughout the new year.

Two Quick Ways to Improve Business Cash Flow Next Year

Avoiding life’s negatives is generally a noble aim. And when it comes to cash flow, every business owner wants a positive outcome. Running low on cash signals trouble ahead. Judicious management of cash flow is more crucial to sustainable operations than generating new sales. After all, a business can survive slower revenue, but not without cash. The usual methods for enduring a cash crunch are establishing a line of credit, negotiating terms with vendors, and offering discounts for early-paying customers. Implementing a couple more creative measures, however, can result in permanent cash flow enhancements.

One important cash-saving procedure is timely remittance of taxes. Income tax payments in particular are supposed to be made in equal installments throughout the year. Penalties are assessed if you underpay the required estimated tax installments. Waiting to pay after year-end may mean parting with a surprisingly large chunk of cash. If you’re not sure how much taxable income to expect for the year, the IRS has a “safe harbor” formula based on your tax in the prior year. Your accountant can make this calculation, but doing so necessitates filing your tax return by the initial due date.

Another technique can improve cash flow for a business that receives recurring customer payments, such as contract work. This is accomplished with direct electronic payment using the Automated Clearing House (ACH). ACH transactions may be established with your customers to push funds directly to your bank account. Similarly, an ACH direct debit arrangement permits your bank to pull funds from a customer for preauthorized amounts. These methods eliminate invoicing and waiting for payment. The result: faster cash flow and a better bottom line.

Attention Cash Basis Bookkeepers: Watch for Accrual Entries

Most small businesses maintain their bookkeeping on a cash basis of accounting, recording revenue and expenses only when money flows in or out. By contrast, accrual accounting records revenue when earned and expenses when incurred. Cash basis is easier and provides a satisfactory financial picture if your business is generally paid promptly by customers and pays its bills immediately upon receipt. Nevertheless, some transactions are necessarily accounted for as accruals even by cash basis operations. These are most often amounts that will be remitted in the future for taxes.

For example, payroll taxes are expensed by a business on payroll dates, but remitted on future days. Payroll taxes that are deducted from employee pay are part of the company’s expense for wages, although the withheld amounts are not paid simultaneously with net paychecks. The employer part of payroll taxes is another expense category that’s also recorded on payday.

Because payroll taxes are remitted at a later date, recording the expense on payday is offset by an accrued liability on the balance sheet. If the taxes accrued for remittance in the future are not recorded on the balance sheet, the expense will not appear on the income statement. Profit is therefore overstated due to the missing expense.

When an accrued amount of payroll taxes is eventually remitted, it has no impact on the income statement because the expense has already been recorded. The remittance applies to the accrual on the balance sheet.

To assure accuracy of expenses, it is essential to constantly examine the accrued tax liabilities on your balance sheet. This close watch will help you avoid financial surprises.

Preparing a Business Budget for the New Year

Every business owner has goals, and achieving them requires a bit of planning. Because goals are linked to money, a proper plan includes devoting a little time to budgeting.

Fortunately, you don’t need an elaborately detailed budget like that of a multinational corporate behemoth. Simply having an outline connecting spending and revenue is sufficient. Setting aside a planned amount of cash for spending later assures you have sufficient funds for future plans to succeed. A budget tells you what is and is not a financially sound decision.

Making the Business Budget

You can create a budget using the old-fashioned tools of pencil and paper, but this is only a good starting point. After sketching out a general income and spending pattern for next year, placing the numbers in electronic format will help when filling in the remaining details.

Spreadsheet applications on your computer will work nicely. Perhaps your bookkeeping software gives you an option to place budget figures into it. This will benefit you later when comparing your budget to actual results.

Start the budget process by estimating an amount of monthly revenue based on available resources. Your income is limited by how much time you work, the equipment you possess, and the prices you charge.

Moreover, you may need to adjust income based on your cash resources. That’s because higher income may lead to paying more expenses prior to collecting from your customers. The money you have for expenses puts a cap on how many customers you can serve.

Using the Business Budget

The budget shows a timeline for building cash over time. A controlled growth rate and a tight rein on spending allow your cash to gradually increase. This capital reserve is then available to fund further growth with new customers.

The timing for a rising cash flow depends greatly on when customers pay you. A lot of businesses are paid a month or more after work is completed.

That means your budget will show you deploying your available resources and paying your bills one month, but collecting the revenue over the next month or two.

Over those next couple of months, you will spend more time and money on additional work. Your budget should indicate, however, that you have a little more cash than when you started. That’s because the revenue received exceeds your costs. This is the profit you aim to accumulate and then spend for tackling more customers.

To ensure that you achieve profit accumulation, monitoring your actual business performance is crucial. The budget predicts increasing business cash flow, but turning that expectation into reality necessitates comparing actual to budget.

Obtain your statement of revenue and expenses after the first few months projected in your budget. You want the report that has revenue you already collected and expenses you already paid. Put these numbers in the same spreadsheet as your budgeted revenue and expense categories for the same months.

Is your revenue coming in as you expected? Is your spending on track with the budget?

Most likely, you will uncover areas where you have excelled and others where you’re falling short. Making the necessary adjustments will propel you to meet your annual goals.

Donations and Deductions: What You Need to Know

Taking a tax deduction for items donated to charities is a common practice for millions of individuals. But what about tax deductions for donating business property? This process is a bit more complex.

A personal income tax return is where most business owners deduct the charitable contributions of their companies. Only a regular C corporation deducts donations on the income tax return of the business. Sole proprietors, partners in partnerships, shareholders in S corporations, and everyone with a limited liability company (LLC) treat charitable contributions by the business as if they had been made personally.

How much?

The amount of tax deduction that an individual takes for donating personal property is typically the fair market value of the donated item. Fair market value is simply what an ordinary buyer would pay for the item and what an ordinary seller would agree to accept for selling the item. In other words, the tax deduction is whatever amount of money the charity receiving the donated item can get from selling it.

A general exception, however, is that the individual cannot deduct more than what was originally paid for the item. This amount is known as the basis of the property. For example, donation of business inventory results in a tax deduction for the cost rather than the fair market value of the items. Likewise, the tax deduction for donations of art, literature, or music is limited to the cost of creating it.

Conversely, an asset specifically held for appreciation in value may, in most cases, be treated as if it were sold and the proceeds donated. The deduction in these instances is the fair market value, not the basis. This is true, for example, of investments in qualified shares of stock.

What about accounting?

Thinking about the bookkeeping for a business, it’s easy to see the complexity of deducting fair market value for a donated item. Unlike inventory, the basis for most items is $0, because the business already deducted the cost at the time of purchase. Therefore, the charitable deduction is limited to $0. Office supplies and most small equipment fit this description.

Long-lived fixed assets are generally not expensed when purchased. Their cost is depreciated over time. If the original cost has not yet been fully depreciated, these items have a basis above $0. Basis for these items is the part of original cost not yet depreciated.

The basis for fixed assets is found on the company’s balance sheet, which is the financial statement showing assets balanced against liabilities and equity. When a charitable donation is recorded, the asset’s basis is removed, the expense lowers profit, and equity decreases.

However, the bookkeeping technique is different if the deduction is not limited to the asset basis.

For example, what if the fair market value of the donated item is lower than its basis? In these instances, the business deducts the part of the basis that is not deducted as a charitable donation as a loss on asset disposal.

In rare cases, if the fair market value is more than basis, the business may choose to report a gain on disposal of the asset.

Do you need to record a charitable donation from your business? To ensure proper navigation of these bookkeeping measures, consult with your tax adviser for assistance with business asset donations.

Worth the Expense? Measuring the Impact of New Initiatives

An entrepreneur makes changes in the business not merely to improve satisfaction or add excitement, but also to increase profitability. Determining if these creative actions are adding to the bottom line begins with identifying which categories on the business income statement are impacted by initiatives.

Typically, a change entails some additional spending in the near term that’s aimed at delivering benefits later. For instance, crafting a new sales strategy or marketing campaign will increase certain selling expenses. How can you tell if the expenses were worthwhile? Monitor the changes by comparing marketing costs after implementing the new strategy with the costs in these same categories under your old sales process (be sure to compare with the same time period last year). Later, examine revenue to see if you achieved the expected rise that should follow a successful program.

Other potential changes are new products, added services, a different menu, or a big sale. All of these enhancements are aimed at improving output, supplying an increasing number of customers, and improving sales. These goals are commonly preceded by higher expenses, such as acquiring product samples, adding a new employee, paying for new printing or promotional materials, buying extra advertising, and making changes to your website. To measure their impact, compare the increase in relevant expense to the increase in revenue. This ratio reveals how well your new actions have succeeded.

Some innovations are intended to increase profit without raising revenue. They simply aim to reduce expenses. For example, a new physical layout for your business may inspire easier workflow. If such innovations are worthwhile, your income statement will show an increasing profit margin due to lower costs. Success!