Small Business Tax Deduction Strategies

13 tips on achieving write-offs through donations, retirement plans, IRA transactions, home sales, business equipment and trusts

Small Business Tax Deduction Strategies

Savvy small business owners take a proactive approach to seizing all the business tax deductions they’re legally entitled to under current tax law. Don’t add to your tax bill by overlooking crucial write-offs.

Small Business Tax Deduction Strategies lays out 13 shrewd tax-planning moves you can make to reap the biggest tax savings. Tax laws change fast, so always keep an eye on the news!

Small Business Tax Deduction Strategies #1

7 tax moves for a small business

As with individuals, tax reforms could potentially affect your small business, but the prospects are still uncertain.

Strategy: Take advantage of current loopholes in the tax law. By making smart moves at the end of the year, you might save your business thousands of tax dollars.

Following are seven tax strategies that may work out for your situation.

1. Max out on Section 179. Under Section 179 of the tax code, a business can currently deduct, or “expense,” the cost of qualified new or used property placed in service during the year, up to a stated limit. The Protecting Americans from Tax Hikes (PATH) Act permanently preserved a maximum $500,000 allowance, subject to inflation indexing. But the deduction is limited to your taxable business income and reduced dollar-fordollar for acquisitions above a $2 million threshold, also indexed for inflation.

Tip: The maximum allowance for 2017 is $510,000, and the threshold is $2,030,000, respectively. Keep these limits in mind at the end of the year.

2. Pounce on bonus depreciation. Besides the Section 179 allowance, your business may be able to claim “bonus depreciation” for qualified property placed in service in 2017. But this tax break, which was also reinstated by the PATH Act, is being gradually phased out. It remains at 50% through 2017, before dropping to 40% in 2018 and 30% in 2019. After 2019, bonus depreciation is scheduled to completely expire, so plan accordingly.

Tip: Unlike the Section 179 provision, bonus depreciation is limited to new property. Used property doesn’t qualify.

3. Spruce up business premises. Generally, amounts paid to improve tangible property must be capitalized and depreciated over time, but recent regulations provide a unique opportunity. Under a safe-harbor election in the regs, your small business may currently deduct certain building costs above and beyond the maximum Section 179 allowance. Among other requirements spelled out in the regs, the election is limited to $500 for a specific item or $5,000 if you have an “applicable financial statement” audited by a CPA.

Tip: This election is only available to qualified small businesses with $10 million or less of average gross receipts.

4. Salvage a bad debt deduction. If you haven’t been able to secure payment for products you’ve distributed or services you have performed, you have a tax ace up your sleeve. At least you can still deduct business bad debts that have become totally worthless if you make good-faith efforts to collect the past-due amounts. Keep detailed records of all your collection activities. This documentation might be needed to support claims of worthlessness if the IRS challenges the deductions.

Tip: If you use the specific charge-off method, you can deduct business bad debt that has become partially worthless during the year.

5. Speed up deduction for bonuses. If you operate your company on the accrual basis, you can deduct year-end bonuses in the current year as long as they are paid within 2½ months of the close of the tax year. Therefore, a calendar-year business may deduct bonuses on its 2017 taxes, even if the compensation is paid as late as March 15, 2018. But this special deduction rule doesn’t apply to bonuses paid to majority shareholders of a C corporation or certain owners of S corporations or personal service corporations.

Tip: Spell out details of bonuses in your corporate minutes.

6. Switch inventory methods. For inventory valuations, a business will generally use either the “first in, first out” (FIFO) method or the “last in, first out” (LIFO) method. Under FIFO, the first goods acquired are considered the first ones sold. With LIFO, the last goods acquired are treated as the first ones sold. If prices in your industry have risen, you might consider switching from FIFO to LIFO at year-end. Because the inventory is based on a higher price to your business, your taxable gain is reduced.

Tip: You can continue to benefit from the FIFO method if prices keep rising.

7. Jump-start a business venture. Instead of taking write-offs over time, you may deduct up to $5,000 of your qualified startup expenses paid this year. Startup expenses are generally costs that would normally be deductible by an ongoing business entity. For instance, this might include certain advertising and marketing expenses, as well as fees paid to outside consultants. But make sure you’re actually “open for business” before Jan. 1, 2018. To qualify for the fast write-off, you must have commenced operations in 2017.

Tip: Any startup expenses above the $5,000 limit must be amortized over 180 months.

Small Business Tax Deduction Strategies #2

3 good ideas for bad debts

Are you having trouble collecting money for goods or services your business has provided? Consider three strategies for securing bad-debt deductions.

1. Prove it’s worthless. Your company can deduct a bad business debt in the year it becomes partially or totally worthless. However, if the debt isn’t worthless (i.e., it can still be collected), you’re not entitled to any deduction. If the debt is a customer receivable owed to your business, you must use the accrual method of accounting and have accrued income from the receivable to claim a later bad debt write-off.

Strategy: Keep detailed records of all your company’s efforts to collect bad debts.

This includes any correspondence such as dunning letters, emails, telephone calls or efforts by a collection agency. These records are the best proof of worthlessness if the IRS comes calling.

2. Separate business from personal. In contrast to business bad-debt deductions, a nonbusiness bad debt is deductible only when it becomes totally worthless. Also, the debt is treated as a short-term capital loss, which can only be used to offset capital gains plus up to $3,000 of ordinary income.

Strategy: Establish in your corporate minutes that business bad debts aren’t personal advances or loans.

To be deductible as a bad business debt, a loan must be tied to your business or result in a business loss if it goes sour.

3. Pay yourself now or pay later. The IRS often questions bad-debt deductions for loans made by employee shareholders to their companies. It may say the loan represents a contribution to the capital of the employer entity.

Strategy: Make sure you’re paid a reasonable salary in the year you take a bad-debt deduction.

This shows your main motive was to protect yourself as an employee (not an employer), which will permit a bad-debt deduction if the loan isn’t repaid. Note: If you lend the company more than the compensation you’re receiving, it’s likely the advances will be treated as contributions to capital.

Tip: A nonbusiness bad-debt loss is better than nothing.

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Small Business Tax Deduction Strategies #3

Shelter a personal residence from tax

The generous federal estate tax exemption can shield most estates from the federal estate tax, but some wealthy individuals need extra protection, especially if they own a lavish home.

Strategy: Set up a qualified personal residence trust (QPRT). This allows you to remove your home from your taxable estate with a reduced or no gift tax obligation.

In some cases, a QPRT can save your family hundreds of thousands of tax dollars.

Here’s the whole story: With a QPRT, you create a trust and transfer a home to it, naming yourself as trustee. The place can be your primary residence or a vacation home.

As the grantor, you retain an interest after the transfer to the trust, just like you would with a grantor retained annuity trust (GRAT). Usually, the interest is the ability to live in or use the home for a certain period of time.

Note, however, that unlike GRATs, QPRTs don’t generate a stream of income during the trust term. At the end of the term, the home passes to the trust beneficiaries, usually your children, so you’re making a taxable gift. Because it’s a deferred gift, the taxable gift may be a fraction of the current value, based on the prevailing Section 7520 rate.

Example: You transfer your $1 million home to a QPRT in 2017 at age 60 and retain the right to live there until age 80. If you outlive the trust term, the home passes to your three children.

Assuming a Section 7520 rate of 2.4% (the rate in June 2017), the initial taxable gift is valued at around $361,000. As long as your lifetime gifts don’t exceed the unified $5.49 million estate and gift tax exemption, no federal estate tax will be owed, although a federal gift tax return must be filed. (Caution: There may be state tax consequences.)

If you survive the 20-year term, the residence passes to your children, free of any federal gift or estate tax consequences.

Suppose that the home is worth double its current value at that point. As a result, you’ll have passed a $2 million home to your children at a gift tax cost of a mere $361,000. Because this is a gift of a future interest, the $14,000 annual gift tax exclusion isn’t available.

Tip: This is just a quick overview. Obtain more details from an estate planning pro.

Small Business Tax Deduction Strategies #4

Focus on constructive dividends

When a small business corporation is successful, it may pay out dividends to its shareholders, including the owner running the company. Although dividends paid by C corporations are taxable to the extent of the company’s earnings and profits (a tax term of art), they generally are eligible for preferential federal income tax treatment, just like long-term capital gains. Currently, the top federal rate on qualified dividends received by an individual taxpayer is 15%, or 20% if you’re in the top rate bracket.

Conversely, compensation is taxable to recipients at ordinary income rates, but these amounts are deductible by the company. Dividends are not deductible. For this reason, C corps usually prefer for payouts to shareholder-employees to be treated as compensation rather than dividends.

New decision: A husband and wife, residing in California, were the sole shareholders of a C corp (51% for the husband, 49% for the wife) involved in helping to originate home mortgages. The company acted as an independent contractor for California Mortgage Group (CMG), soliciting clients. After selected clients were referred to CMG, they were offered mortgages.

During the tax years in question, the wife was the only employee of the corporation, while the husband worked full time at a high school, supervising and teaching special needs students. The wife’s sole responsibility for the corporation was client recruitment for CMG. She kept a desk in CMG’s main office and worked there at least two days a week. She also testified at trial that she worked from home the rest of each week and usually met clients at home or a public place.

For 2012 and 2013, the corporation deducted numerous expenses, including travel and entertainment expenses, insurance, telephone expenses, advertising and gifts, medical expenses, utilities and maintenance, dues and subscriptions and depreciation. Some of these expenses were used for repairs to the couple’s personal residences, to buy swimming pools and for personal entertainment.

The IRS challenged most of the reported expenses due to lack of substantiation or a valid business purpose. It said the payments constituted disguised dividends.

Tax result: The Tax Court sided with the IRS. Many of the corporation’s expenses that were labeled as marketing and promotional payments were actually used for personal purposes and directly benefitted the shareholders. Thus, the payments were nondeductible disguised dividends that benefitted the shareholders rather than deductible expenditures that benefitted the corporation. (Luczaj & Associates, TC Memo 2017-42, 3/8/17)

Small Business Tax Deduction Strategies #5

Nail down casualty loss deductions

At this time of year, taxpayers throughout the country are at risk for various types of natural disasters, including hurricanes, tornadoes and wildfires.

Strategy: Keep detailed records if your personal (nonbusiness) property is damaged or destroyed. Although it is small solace, you may be able to claim a casualty loss deduction on your tax return.

Generally, losses from all casualties during the year are lumped together for tax purposes. However, your annual deduction is subject to strict limits.

Here’s the whole story: To qualify for a casualty loss deduction, the regulations say that the damage must be caused by an event that is “sudden, unexpected, or unusual.” Typically, this includes damage from natural disasters like hurricanes, tornadoes, earthquakes and the like; but it also applies to events like car collisions. But deterioration or wear and tear occurring over a long period of time—such as loss of property due to a drought or insect infestation—isn’t eligible for the deduction.

The umbrella for casualty losses also covers vandalism and theft of property. All these events are treated the same tax wise.

But you can’t just deduct the full amount of your loss. For starters, the amount of your personal casualty loss is limited to the lesser of:

  • The adjusted basis of your property
  • The decrease in fair market value of your property as a result of the casualty.

For income-producing property (e.g., rental real estate) that is completely destroyed, the amount of your loss is limited to your adjusted basis in the property.

The adjusted basis of your property is your cost plus certain adjustments for improvements and depreciation. For example, if you acquired your home for $500,000 and added an in-ground swimming pool and deck for $100,000, your adjusted basis in the home is $600,000.

In addition, the deductible loss must be reduced by any insurance reimbursements you receive. File a timely insurance claim for any loss. Otherwise, you can’t deduct the loss on your return.

Finally, after you’ve figured out the amount of your loss that is potentially eligible for the deduction, two subtractions apply in determining the deductible loss amount:

1. Your total loss deduction for the year is reduced by 10% of your adjusted gross income (AGI).

2. The loss deduction is also reduced by $100 for each casualty or theft loss event.

Example: You expect your AGI in 2017 to be $100,000. So far, it’s already been a bad year for you. In February, a severe storm caused damages of $10,000 above insurance to your home. In June, you were involved in an auto mishap, and it cost you $2,500 out-ofpocket to get your car fixed. And then your newly repaired car was vandalized in August, setting you back another $1,000 after the insurance reimbursement.

On these facts, there were three separate casualty events during the year. After each loss is reduced by $100, the total potentially eligible for the casualty loss deduction is $13,200 ($9,900 + $2,400 + 900). Because 10% of your AGI is $10,000, your write-off for 2017 is limited to $3,200 ($13,200 – $10,000).

Personal casualty losses are claimed on Schedule A of Form 1040 along with your other itemized deductions. Therefore, if you’re a nonitemizer, you get zero tax benefit from casualty losses. Assuming you qualify, make sure you have proof of the amount of losses in case the IRS ever challenges the deduction. Store all the pertinent documentation and visual evidence (e.g., videos or photographs) in a secure location.

Tip: These rules apply to losses of personal (nonbusiness) property. There is no $10%-ofAGI threshold or $100-per-event reduction for business property casualty losses.

Small Business Tax Deduction Strategies #6

Score tax breaks for business meals

A new decision made in favor of a hallowed professional hockey team may lead to tax breaks for employers of all stripes.

Strategy: Furnish meals to employees when it suits your business purposes. If certain requirements are met, the meals are tax free to the employees as a fringe benefit and deductible by your company.

Generally, the meals must be furnished on-site to qualify for this double-dip. But the new decision involving the Boston Bruins, one of the NHL’s original six franchises, shows that off-site meals may be eligible under certain conditions. (Jacobs, 148 TC No. 4, 6/26/17)

Here’s the whole story: Food and beverages provided by a business are tax free to employees if they are furnished for the convenience of the employer and they are served on the business premises. However, meals are furnished for the employer’s “convenience” only if there’s a substantial noncompensatory business purpose. For instance, this may occur when workers are “on call” for emergencies.

Normally, an employer can deduct only 50% of the cost of those meals provided to employees, but there are a few key exceptions to this rule. For instance, an employer may deduct 100% of the cost of meals that qualify as a “de minimis fringe benefit” (e.g., when it operates a cafeteria for the benefit of employees).

Facts of the new decision: The NHL imposes strict rules on teams regarding travel to away games. Accordingly, the Bruins made arrangements for food and lodging for players and staffers at various hotels during the season. Typically, the hotels provided banquet rooms where meals and pregame snacks were served.

After the owners deducted 100% of their pre-game meal costs under the exception for eating facilities, the IRS disallowed the deduction. The case wound up in the Tax Court.

First, the Tax Court determined that the meals would qualify as a de minimis fringe benefit only if they were provided in a “nondiscriminatory” manner. Because the entire staff traveling with the team could partake in the meals, the Bruins met this requirement.

Second, the Tax Court examined whether the eating facility met the following requirements in the applicable regulations:

  • The eating facility must be owned or leased by the employer.
  • The facility must be operated by the employer.
  • The facility must be located on or near the business premises of the employer.
  • The meals must be furnished during or immediately before or after the workday.
  • The annual revenue derived from the facility must equal or exceed its direct
    operating costs.

The hang-up in this case was the requirement that the facility be located at or near the employer’s business premises. But the Tax Court determined that this requirement was met. Its rationale: The hotels where the Bruins stayed were places where they were conducting business on road trips. Therefore, the deduction for 100% of the meal costs was allowed as a de minimis fringe benefit.

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Small Business Tax Deduction Strategies #7

Steer clear of prohibited IRA transactions

To paraphrase John F. Kennedy, it’s not what you do in your IRA, it’s what you can’t do.

Strategy: Don’t engage in any “prohibited transactions.” The penalties can effectively wipe out the benefits you received from your IRA in the first place.

Other rules limit the type of investments you can make with IRA funds.

According to the IRS, a “prohibited transaction” is an improper use of an IRA by its owner, the IRS beneficiaries or any disqualified person. For this purpose, a “disqualified person” includes IRA fiduciaries—for example, a professional responsible for managing the IRA funds—or some other family member.

The list of prohibited transactions is a long one. It includes:.

  • Borrowing money from the IRA
  • Selling property to the IRA
  • Using the IRA as security for a loan
  • Buying property for personal use with IRA funds
  • Receiving unreasonable compensation for managing IRA funds.

But note that withdrawing funds from an IRA and then depositing the same amount back into the IRA, or a different IRA, within 60 days is treated like a rollover and won’t trigger any dire consequences.

What are the penalties? When a prohibited transaction occurs, the account stops being treated as an IRA as of the first day of the year of the violation. Net effect: You’re treated like you received a taxable distribution of all the IRA assets on Jan. 1 of that year. In that case, you owe ordinary income tax on the difference between the value and your basis, as with any other withdrawal. If you’re in the peak earning years, you’ll have to pay tax at rates reaching up to 39.6%.

Tip: To add insult to injury, you’ll generally owe a 10% penalty tax if you’re under age
59½.


No-nos in your IRA

Generally, you can’t use IRA funds to invest in collectibles, including the following:

  • Artwork
  • Rugs
  • Antiques
  • Precious metals (with exceptions for certain bullion that meets purity standards)
  • Gems
  • Coins and stamps (with some exceptions)
  • Rare alcoholic beverages
  • Certain other types of tangible personal property.

Tip: A limited exception exists for certain U.S. Treasury gold and silver coins.

Small Business Tax Deduction Strategies #8

Should you own or rent your business premises?

Once your company’s profits begin growing and your business stabilizes, you might want to consider owning your quarters rather than renting.

To evaluate the comparative costs, consider a reasonable length of time, such as 10 years. Include in your calculations the purchase price of a desirable building at the location you want. You can depreciate the cost of the building (“improvements”) but not the cost of the land. Add together the cost of financing 100% of your purchase price at the prevailing interest rate, maintenance costs, straight-line depreciation and property taxes. The total of these items is your “rent equivalent.”

Compare this cost figure with your projected rental costs for 10 years and factor in expected rent increases (4% per year is realistic). Don’t overlook your company’s future expansion needs. Whether you buy or rent, you must be able to expand or contract space as needed. If you plan to own your space, you may want to consider buying a larger building and renting out part of your space on a short-term basis.

How a ‘private arrangement’ can slash your taxes

Suppose you decide to own rather than rent your business property. In that case, you have another decision to make: Who should own the real estate: you or the corporation?

Usually, you would be better off owning the real estate and leasing it to the company if it’s a C corporation. The corporation probably can get a full deduction for the lease payments it makes to you. This will reduce the corporate income tax it has to pay.

At the same time, if you own the building, you can depreciate it. The depreciation deductions can offset all or part of the rental income you receive. If you wind up with a net loss from the property, it might be deductible; even if that’s not possible, you might be able to deduct your payments for real estate taxes and mortgage interest.

Plus, if the building appreciates, it’s easier to cash in on gains (refinancing, property sale) without adverse tax results if you hold it personally rather than through a corporation.

Use property for business? Depreciate it

Depreciation is a tax deduction for the wear and tear and deterioration of property used in business activities. It effectively enables you to “recover” the cost of certain property over time for tax purposes.

Alert: This includes deductions for the depreciation of machinery, equipment, buildings, vehicles and furniture. But you can’t claim depreciation on property held for personal purposes.

If you use property, such as a car, for both business or investment and personal purposes, your depreciation deduction is based on the business or investment use of that property. Special rules and limits often apply, especially if you’re an employee. In some cases, you may qualify for a simplified option, such as deducting the standard mileage rate for business use of a vehicle or claiming the streamlined deduction for home office expenses.

Tip: Usually, you’ll fare better tax wise by keeping track of your actual expenses.

Small Business Tax Deduction Strategies #9

Moving deduction hits the brakes

If you are making a move because of your job, you may be entitled to deduct certain moving expenses.

Alert: The write-off isn’t automatic. To qualify for this tax break, you must meet a twopart tax law test involving distance and time.

Note that the requirements in this area are very specific.

1. Distance test: Your new job location must be at least 50 miles farther from your old home than your old job location was from your former home. For this purpose, the IRS uses the shortest of the most commonly traveled routes to measure the distance between the two points.

2. Time test: If you’re an employee, you must work full time for at least 39 weeks during the first 12 months after you arrive in the general area of the new job. But you don’t have to work for the same employer as long as the 39-week test is satisfied.

Assuming you qualify, you can typically write off the reasonable costs of moving household goods and personal effects to your new home, plus travel expenses (including lodging, but not meals) between the two locations. Normally, this will include charges by a moving company or a truck rental.

As shown in a new case, the IRS is adamant that you must meet both parts of the tax law test.

Facts of the case: The taxpayer, a CPA, pulled up stakes in Pennsylvania and moved to California. He arrived on March 7 and, relying on business contacts, began his job search. On June 7, he signed a one-year employment agreement with a firm, but he did not start working until July 16 and actually received his first paycheck on July 22.

Obviously, this taxpayer had no problem with the distance test, since he clearly moved all the way across the country. But what about the time test? Unfortunately, he doesn’t technically qualify because he did not work for 39 weeks during the 12 months after his arrival. Bottom line: The deduction for moving expenses was denied. (Anderson, TC Summary Opinion 2017-17, 3/16/17)

Tip: When possible, take taxes into account when planning a job-related move.

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Small Business Tax Deduction Strategies #10

When to lease, not buy, equipment

Consider leasing business equipment instead of buying it. Generally, you can write off the entire cost of leasing without a huge upfront commitment. Also, leasing isn’t forever. If the tax breaks for buying property are revived, you may be able to quickly cash in.

Small Business Tax Deduction Strategies #11

Self-employed tax deductions: your home office

While some view the home office deduction as audit bait, you’ll withstand any IRS scrutiny if you know and follow the home office deduction rules.

Here’s how to earn bigger and better deductions without getting off the living room couch.

Home office rules: the basics

Whether you’re a butcher, a baker or a candlestick maker, you can deduct your home office expenses if you use part of your home “regularly and exclusively” as either:

  1. Your principal place of conducting business.
  2. A place to meet or deal with clients, customers or patients in the normal course of business.

Small Business Tax Deduction Strategies #12

Count tax in the 'sharing economy'

Have you become part of the “sharing economy” that is taking the U.S. by storm? For instance, you might provide car-driving services for outfits like Uber or Lyft or rent out a vacant home or room through Airbnb.

Strategy: Be aware of the tax implications. Generally speaking, you’re treated like a self-employed individual as far as the IRS and state taxing authorities are concerned, so you must meet the usual requirements.

Small Business Tax Deduction Strategies #13

Introduce your kids to the Roth

Believe it or not, even your teenagers can benefit from tax-saving retirement plans.

Strategy: Have your child contribute part or all of their summer and after-school wages to an IRA. The contributions can grow into a tidy tax-deferred nest egg over time.

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