Tracking tax write-off transfers

John Sculley III, who was chairman of PepsiCo to become CEO of Apple Inc. for more than a decade, said that “timing is everything”. He was probably referring to business moves, but the sentiment applies with equal force to tax cuts. Due to various limitations on certain tax deductions and credits, you may not be able to use the full amount of a write-off in the year in which it occurs. Instead, unused value can be carried forward and used in future years (or rolled back in limited situations). Fully utilizing the write-offs you are entitled to means carefully tracking these transfers. Here are some of the most common transfers small business owners should look out for and the records you should keep.



general business credit

Trade credits – and there are more than 2 dozen of them – have their own eligibility rules, including the maximum credit amount. However, these credits are subject to a general limitation called general business credit. If the total credits exceed the limit, the excess is carried backwards one year and then forwards for up to 20 years.

Track each year that a general trade credit overrun arises and each year that a transition is used. This is because there is a ordering rule that allows a current deduction first for any carryforwards for this year (the first ones first), secondly for the current year’s trade credits, and thirdly for any carryforwards for this year (these first first).

home office deduction

If you have a home office and don’t use IRS simplified option but instead of deducting your actual expenses for business use of your home, the deduction cannot exceed gross income from business use of the home minus business expenses (“gross income test”). Any unused amount may be carried forward and used in a future year to the extent of the gross income test. This is true even if you move into a new home. Transfers can be used indefinitely, subject to the gross income test.

business losses

If your business expenses exceed your income, you will almost certainly have a financial loss, and you will likely also have a tax bill (limitations on deductions could mean there is a difference between the loss on your books and the tax loss). Suppose you own a business operating as a pass-through entity – a sole proprietorship, partnership, limited liability company or S corporation – and a loss is passed on to you. Your current deduction is limited by a tax rule called the Non-Corporate Loss Excess Limitation. An excess business loss is the amount by which the total deductions attributable to all of your businesses or businesses exceed your total gross income and earnings attributable to those businesses or businesses plus a threshold amount adjusted annually for inflation (see instructions for Form 461).

Any loss that exceeds this threshold becomes part of a net operating loss (NOL). The NOL deduction is calculated using certain adjustments. NOL can be carried forward indefinitely to offset up to 80% of taxable income (agribusiness companies also have a 2-year reporting option). If there are NOLs carried forward from multiple years, use them in the order in which they appear (that is, the oldest are used first).

You must attach a statement to your tax return showing all the important facts about the NOL. The statement must include a calculation showing how you calculated the NOL deduction. If you deduct more than one NOL in the same year due to multiple transfers, your statement must cover each one.

Depreciation

If you purchase certain property for your business and cannot fully account for the cost using first year expenses (Section 179 deduction), bonus depreciation, or a safe harbor created by the IRS (all explained in Publication of IRS 946), you are left with the deduction of an annual depreciation allowance. The depreciation period is a fixed number of years defined by law that depends on the type of property involved. For example, most commercial equipment and machinery is owned for 5 or 7 years, while commercial real estate has a 39-year depreciation period.

It is essential to track annual depreciation provisions so that you can:

  • Continue to claim these deductions until you run out
  • Depreciation recapture figure when necessary

Other transfers

This list is not exclusive, but some other transfers you may come across are related to:

  • capital losses
  • charitable contributions
  • investment interest
  • Passive activity losses
  • prepaid expenses

Conclusion

When it comes to transfers, there is bad news and good news. The bad news is that it’s up to you to track them down; the IRS doesn’t do it for you. The good news is that your tax preparation software (assuming you use the same one year after year) or your CPA or other tax professional will automatically keep the required records of transfers. Don’t let poor record keeping keep you from claiming all the write-offs you’re entitled to.

Image: Envato Elements


Leave a Comment