Tax-Deductible or Not? Ask Your Expert

As business owners prepare to file tax returns, many find they have to reconstruct some of last year’s expenses. This is usually a result of paying business expenditures by personal means instead of through a checking account or credit card used exclusively for business. Delays and frustration result when there isn’t sufficient information, or you can’t remember the details required for some write-off claims.

By hiring an accounting professional, you can be sure every expense deduction your business is entitled to will be captured in a timely manner. Bookkeeping experts know how to record expenses regardless of the payment method. And they understand the conditions that make certain types of expenses tax-deductible.

Double-entry systems

With a double-entry bookkeeping system, every transaction records a balanced combination of debits and credits. Unlike spreadsheet entries, double-entry accounting will debit an expense category and simultaneously record the offsetting credit to an account that shows how the expense was paid.

Using accounting software for do-it-yourself bookkeeping is not a complete solution because it leaves you with the burden of learning about account categories and tax classifications. But when a skilled bookkeeper sees checking account outflow or credit card use, he or she will immediately seek information about the balancing expenditures. Even when your personal funds are spent for business purposes, your accounting professional will know the account that offsets the expenditure.

Normal expenses

A deductible business expense must be necessary and normal for your type of enterprise; personal expenses are never tax-deductible just because they’re paid by your business or have a loose connection to business operations. These types of transactions are considered owner draws.

For example, an accounting professional knows that business owners are prohibited from claiming tax deductions for wardrobe items or personal grooming. Expenditures such as haircuts and gym memberships are strictly personal, regardless of the intangible benefit derived from maintaining a good appearance.

Businesses also cannot deduct costs for the owner’s residence. However, if you meet home office requirements, the business may reimburse you for a percentage of your home expenses. This is based on the portion of your home used regularly and exclusively for business; in most cases, the home office space also must be the primary business location.

Special rules

There are special tax rules that allow deductions for business education and travel. General business education is deductible, but seminars and conferences must maintain or improve skills required in your current line of business.

Business travel is generally associated with overnight stays away from home. A deduction for all the travel cost is allowed when the primary purpose of the trip is to conduct business. When the trip is primarily for pleasure, only expenses directly related to business are tax-deductible. In this case, deductions for transportation and lodging costs are based on the percentage of days during the trip that business is conducted.

Obviously, caution must be exercised when claiming certain tax deductions. Your accounting professional is a valuable source of knowledge about what can – and can’t – be claimed.

Tax Implications of Business Losses

Business profits will always incur income tax, but a business loss does not necessarily provide a tax benefit. Typically, individuals may use business losses to offset income from other sources when determining their adjusted taxable income. But there are limitations.

A business owner with a loss can determine if the loss is tax-deductible by applying at-risk rules. The at-risk amount generally comprises money or property contributed to the activity in question plus the amount borrowed that, legally, the owner must repay personally.

Individuals in partnership businesses are also subject to the at-risk limitation; plus, they must satisfy the requirement for a sufficient tax basis. A partner’s basis is generally the amount of money and property contributed to the partnership, plus the partner’s allocation of undistributed profits that have accumulated over all past periods. A tax basis, therefore, decreases as a consequence of distributions received along with nondeductible expenses.

The income tax consequence for a partnership’s profit or loss is assessed on the individual tax returns of the partners. But deduction of a loss is limited when a partner has no tax basis or at-risk amount. Here, a capital contribution or a personal guarantee of partnership debt is required so the partnership’s pass-through of loss can be deducted from each partner’s personal return.

This presents a complication for limited partners, who avoid liability for the entire enterprise because their exposure to a business is limited to their contributions of cash. That said, having less money at risk may also restrict a limited partner’s ability to deduct a partnership loss.