A short article from the Hartford small biz section about taxes.
This is a Tax Deduction Every Small Business Owner Will Hate to Take this Year ; Gene Marks and Ben Gran
Sometimes business owners have accounts receivable that will never be paid. They may also have inventory that they never use. If this feels like a loss, it’s because it is. Ask your accountant about using it to your advantage and writing it off as a loss on your tax return to help save money at tax time.
Even the most optimistic business owner will look at their accounts receivable and admit that there are some amounts that will never be collected. Perhaps there’s an invoice for a product that was sold to a customer a few months ago, but he hasn’t paid. Or there’s a sweet deal that was cut with a company in Nebraska last winter that’s not returning phone calls anymore.
Some of these receivables aren’t receivables at all. They’re bad deals. And if you meet the requirements under IRS rules, some of these unpaid receivables can qualify as “business bad debts” that can be deductible on your taxes.
Take a look at your inventory. You’ll see lots of inventory that’s being used for jobs or that was freshly purchased specifically for an order received. But there’s other “stuff” that’s just sitting in your warehouse or storeroom. Some of this stuff you bought at a low cost, thinking you’d be able to sell it at a nice profit. Or maybe you purchased it for a customer whose business soon went under and then they couldn’t pay you. Some of that inventory you’re not going to be able to sell. Those purchases were bad deals, too.
Being in business means sometimes making bad deals; it’s inevitable. It doesn’t mean you’re a bad businessperson. It means that you’re just a businessperson. You took some risks and sold stuff to someone who probably didn’t have a great credit history, but you felt confident they’d pay up. Or you bought something for a great price with the hopes of selling it for a larger margin than your typical items. When you make deals and take risks, sometimes things don’t work out. And that’s OK! The fact that you’re still in business means that more of your deals and risks are working out, right? You’re having more successes than failures.
So, what should you do with that bad receivable or un-sellable inventory? Consider getting rid of them both. You could possibly write them off your books. In the case of the inventory item, you could perhaps take it out of your storeroom and physically dispose of it. There are a few options for possible tax deductions when getting rid of obsolete inventory, depending on your method of accounting and your overall tax situation, but the rules are complicated, so talk to your accountant first to see if you qualify.
For example, you might be able to give away the obsolete inventory as a charitable donation to a nonprofit organization, have a clearance sale to sell the inventory at a loss, or physically destroy the inventory if no buyer or recipient can be found. Remember: Not every business will qualify for a tax deduction, and every situation is different — don’t assume that you can get a tax break for getting rid of your old inventory, but talk to your accountant first and see what options you might have.
Getting rid of the bad receivable can help your mood because you won’t instantly get annoyed every time you look at your list of receivables and see that customer thumbing his nose at you. Getting rid of the unusable inventory item can help free up space for better inventory, so it’s potentially a better use of your overhead. Keeping these assets around can take value away from your business. And, as business owners, our job is to increase our company’s value, not do things that diminish it.
More importantly, getting rid of these bad assets can create a tax benefit. Ask your accountant — it could be a deduction. So long as it’s off your books and disposed of, you might be able to take the write-off. So stop being so sentimental and consider taking the deduction.
It might hurt to finally have to accept the reality that you’re never going to get paid for that big customer order, or that you made a bad bet on a batch of merchandise, but taking a few losses is part of the ongoing learning experience of being a business owner. By clearing out the bad deals and bad debts, you can make way for fresh new opportunities — and you might even be able to claim some of these losses as a tax deduction.
And even if you don’t qualify for as large of a tax break as you had hoped, it will still feel good to close the books on those bad deals, so you can move forward confidently into the future, instead of regretting the past.
As a small business owner, you can save money on taxes in a variety of ways. In addition to writing off business bad debts, you may want to consider using IRS-compliant accountable plans to reimburse employee expenses, or sheltering profits in a retirement plan
a comment about the article:
If I am correctly remembering what my CPA told me, writing off bad debt and unsalable merchandise/inventory only applies if the company is on accrual basis as you have already paid tax on the uncollected money and declared the inventory. If on the cash basis you can not deduct either as you have already deducted the materials and have yet to collect and deposit the receivable.
Check with your CPA or tax advisor