Tax Strategies to Help Your Company Ride Out a Recession

INVENTORY

Keep tight control over your merchandise to help cut the cost of carrying inventory at a time when sales may well be down. How…

• Offer slow-moving inventory for sale. If your inventory has declined in value, you can deduct the decline as a tax loss as long as you offer to sell the inventory at a lower price. Even if the merchandise doesn’t sell, you’ll be entitled to deduct the loss. Put the items up for sale for at least 30 days after taking a physical inventory and then carefully document your sales attempts.
• Deduct shrinkage. Losses due to theft, breakage, bookkeeping errors, and similar occurrences is called shrinkage. Shrinkage can be deducted even if a physical inventory is not taken at year-end but, instead, at some time during the year (to determine the extent of shrinkage). You merely have to estimate inventory on December 31 to claim shrinkage.
• Donate inventory. Can’t sell it? Donate it to charity. Usually, the deduction for the donation is based on the item’s fair market value on the date of the contribution, reduced by any gain that would have been realized if it had been sold instead of donated.

Example: An item that cost you $20, but today is worth $15, would create a deduction of $15.

Some items donated by C corporations are eligible for an enhanced deduction. For instance, the deduction for inventory that will be used for the care of the ill, the needy, or infants can be increased by 50% of the difference between the items’ basis (cost) and their fair market value. But in no event may the write-off exceed 200% of the items’ basis.

Important: After donating the items, remove them from your opening inventory account (how you value your inventory at the start of the year). If the inventory was manufactured by you (instead of purchased), also remove from the cost of goods sold your materials, labor, and other indirect costs that were included in the cost of production (essentially, cost of inventory).

SELL AGGRESSIVELY

Offer discounts and promotions to generate sales. You can’t deduct price reductions—they simply reduce the income that you collect and are taxed on. Hopefully, however, you’ll see greater revenue from your marketing efforts.

THE BARTER OPTION

Using barter to obtain the goods and services that your business needs will help you preserve precious cash. Bartering may be especially helpful in disposing of excess inventory. You can accrue barter credits through a bartering group or association that can be used later on.

For tax purposes, bartering does not let your business avoid income—you must include in income the value of goods or services you receive in exchange for your goods or services.

Example: If a carpenter builds shelves for a clothing store in exchange for some of the items in the store, the carpenter reports income based on the value of the clothing he received.

Barter transactions are reported to the IRS on Form 1099-B, Proceeds from Broker and Barter Exchange Transactions.

Barter transactions are subject to sales taxes, just as if you had paid cash for the item. Therefore, you have to use cash to pay the sales tax.

BAD DEBTS

A business can experience bad debts because of sales to customers that go unpaid, or because of loans to suppliers, employees, or other business connections that are not repaid. If these business bad debts become partially or wholly worthless, the business may be entitled to a bad debt deduction on its tax return. You must show that the debt has become worthless (for example, the buyer has permanently left the country or died without any money, or there’s an uncollectible judgment against him/her). But you don’t have to wait until a debt actually becomes worthless if you know there’s no hope of recovery (for instance, a loan to a business that’s received a discharge in bankruptcy).

Don’t let your accounts receivable age without smart collection efforts. Stay on top of slow-paying customers, limit credit to buyers with questionable credit histories, and, if necessary, use professional assistance (an attorney or collection agency) to collect outstanding receivables.

Accrual-basis businesses can use the “specific charge-off method” to deduct losses related to receivables to offset the income that they accrued when they completed the initial sales transaction. No bad debt deduction can be claimed for estimated losses, only for actual losses.

Cash-basis businesses, such as professionals who perform services, cannot deduct bad debts that arise when clients or customers fail to pay their bills—since the businesses never reported the income, they cannot take a deduction.

Note: If you deduct a bad debt that you recover in a later year, you may have to report the recovery as income in the year that you receive it.

BENEFITS OF ABANDONMENT

If you own property—equipment or inventory—that has lost all of its value to you, consider abandoning it to claim a tax loss.

If the property is depreciable, abandonment allows you to deduct the remaining basis (the part of the property’s cost that has not yet been depreciated). This is treated as an ordinary loss.

If you abandon inventory, you don’t take a deduction. Instead, you adjust your inventory valuation to reflect the actual value, which may be scrap value or zero.

Abandonment requires a physical act, such as trashing the item or removing it from your premises. You can’t take an abandonment loss by merely making a notation in your books while retaining the item.

LOSS CARRYBACKS

When expenses exceed your revenues for the year, you may have a net operating loss. If you had a loss in 2007, you can use it to get an immediate infusion of cash. You can carry back a net operating loss for two years (longer periods in special situations, such as for Hurricane Katrina victims). The loss carryback will offset your income in those years so that you can get a tax refund.