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Sometimes, you can’t use all of your tax deductions and credits in the year they come up because of various rules. So, what happens to the leftovers? Well, you can carry them forward to future years or even back in some cases. It’s like having a savings account for your tax write-offs, and knowing how to manage it can be super handy.
John Sculley III, who was the big boss at PepsiCo before moving to Apple, once said, "timing is everything." He was probably talking about business strategies, but it’s just as true for tax write-offs. Let’s look at some common carryovers that small business owners should keep an eye on and the records you need to maintain.
First up, we have the general business credit. There are over two dozen business credits, each with its own rules, including a cap on the amount. But they all fall under a bigger umbrella called the general business credit. If your total credits go over this limit, the extra can be carried back a year and then forward for up to 20 years. It’s important to keep track of when you have an excess credit and when you use a carryover.
Next, let’s talk about the home office deduction. If you have a home office and choose to deduct your actual expenses instead of using the IRS’s simplified option, there’s a limit to how much you can deduct. This limit is your gross income from the business use of your home minus business expenses. Any unused amount can be carried forward to future years. This still applies even if you move to a new home.
Then there are business losses. If your business expenses are more than your revenue, you have a financial loss. This loss can also be a tax loss, depending on certain rules. If you own a business that operates as a pass-through entity, like a sole proprietorship, partnership, LLC, or S corporation, and a loss is passed through to you, your current deduction is limited by a tax rule called the noncorporate excess loss limitation. Any loss over this limit becomes part of a net operating loss (NOL), which can be carried forward indefinitely to offset up to 80% of taxable income.
Depreciation is another area to consider. If you buy certain property for your business and can’t fully expense the cost in the first year, you can deduct an annual depreciation allowance. The length of the depreciation period depends on the type of property. It’s crucial to track these allowances so you can continue to claim these deductions until they’re used up and figure out recapture of depreciation where required.
There are also other carryovers related to capital losses, charitable contributions, investment interest, passive activity losses, and prepaid expenses.
Now, the not-so-great news is that it’s up to you to keep track of these carryovers. The IRS won’t do it for you. But the good news is that tax preparation software or your CPA will automatically keep records of carryovers. So, don’t let poor recordkeeping stop you from claiming every write-off you’re entitled to.
