A tax deduction is a way to recoup part of the financial outlay for goods and services. However, actions you've already taken (and already paid for) may entitle you to significant write-offs on your current return—without spending one cent more. Here are some “free” business deductions you may be able to take advantage of.
Domestic Production Activities Deduction
If your business makes, grows or extracts something in the U.S., you may be eligible for the domestic production activities deduction. It is a deduction of 9 percent of your qualified production activities income (QPAI) for the year, regardless of any other write-offs you take. Qualifying domestic production includes:
The manufacturing of tangible personal property
The production of computer software, sound recordings and certain films
The production of electricity, natural gas or water
Construction, engineering and architectural services
According to the IRS, clothing stores and wholesalers do not typically qualify since they are resellers; they do not produce the products they sell. Also, professional service companies (other than engineers and architects) do not typically qualify since they are selling their services, even if they produce a tangible item, such as a legal document prepared by an attorney.
The deduction cannot be more than your adjusted gross income, or if your business is a C corporation, its taxable income. Also, it cannot be more than 50 percent of W-2 wages paid to employees. You can learn more about this write-off in the instructions to IRS Form 8903.
Depreciation on Real Estate
If your business owns a building—an office, factory, strip mall or other commercial space—you can take an annual no-cost deduction called depreciation. You can write-off the cost of the building over 39 years, starting with the month in which the business was placed in service; the depreciation rate is fixed by law. You claim depreciation until you have fully recouped the cost of the building or you sell it, whichever occurs first.
For example, on July 1, 2012, you buy a small office building that cost you $1.2 million ($1 million for the building; $200,000 for the land) and begin to rent it out immediately. Your depreciation deduction for 2012 is $11,770 ($1 million x 1.177 percent). The depreciation deduction in each subsequent year is $25,640 ($1 million x. 2.564 percent).
The deduction applies whether you pay cash for the purchase or finance it with a mortgage. The deduction, which is explained in detail in IRS Publication 946, is claimed without regard to your profitability or any other limitation.
Write-offs for Carryovers
The tax law limits certain deductions but allows for carryovers of unused amounts. These carryovers can be deducted in future years to reduce income in those years—without spending any more to generate the deduction. Here are some common business carryovers you may have and their limitation periods.
Home office deduction. Current deductions are limited to gross income from the home office activity. Excess amounts have an unlimited carryforward period.
Net operating losses. Losses from business operations can be carried back usually for two years. Unused amounts can be carried forward for up to 20 years.
Excess retirement plan contributions. Retirement plan contributions in excess of the limit for the current year generally can be deducted in the subsequent year.
Charitable contributions. Charitable contributions cannot exceed certain adjusted gross income limits for sole proprietors, partners, and S corporation shareholders or 10 percent of taxable income for C corporations. Unused amounts can be carried forward for 5 years.
Prepayments. of insurance premiums, subscriptions and other items. If your business reports its income and expenses on the cash method of accounting and you prepay expenses covering a period of more than 12 months, part of the payment must be deducted in future years. For example, on January 1 you pay for a three-year subscription to a professional journal. Only one-third is deductible this year; one-third will be deducted next year and one-third the year after.
In addition to tax deductions, you may also have a general business credit carryforward from unused tax credits in previous years. These business credits may be from research, hiring certain employees, setting up retirement plans or making certain energy improvements. The carryforward reduces your tax in future years on a dollar-for-dollar basis. The carryfoward period is limited to 20 years.
Work with your tax advisor to mine old tax returns for write-off opportunities now and in the future that you can claim without making any additional expenditures. The write-offs are yours for the taking!
Have you overlooked any of the available deductions noted here?
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business, and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® at www.barbaraweltman.com and host of Build Your Business radio. Follow her on Twitter @BarbaraWeltman.
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