What You Need to Know about Bad Business Write-Offs
Bad business write-offs are a widely accepted way for businesses to save money on taxes. Generally, any business loss can be recorded as a tax write off, and can be applied as a tax credit. The standard wisdom is that all tax write offs are good- as long as they are reasonable. But sometimes using write-offs can backfire. We will discuss what write-offs are, and how they can turn around and bite you come reporting time.
Drawing on experience, a company should have a good idea how much it will take in through accounts receivable, and how much of the goods or services rendered will go unpaid. Companies record a bad debt expense for the amount necessary whenever it needs to raise its allowance. This practice stems from the accounting principle of conservatism. That means companies never overestimate holdings- and understanding that failing to recognize the fact that some customers will fail to pay their bills would be naive.
Unfortunately, Debts Do Sometimes Go Bad.
Customers do occasionally fail to pay their bills by the time it comes to make the annual report. Such accounts are uncollectible. When you have determined that a given customer is not going to pay, you write the amount owed off. The write-offs you make don’t always negatively affect your firm’s profitability. Although, there are some exceptions. This is because you have already “expensed” the amount of the bad debt.
It is possible to underestimate the allowance necessary to absorb uncollectible debts. It is also not beyond the realm of possibility that a remarkably large account will turn bad. This can quickly overwhelm the allowance you have established for the fiscal year.
Perhaps a more well-known way to perform a write off is to include everything you acquire or experience as a business related expense. A lot of people assume that you will somehow receive reimbursement for everything you write off. However, this may not always be the case.
Are All Tax Deductions Beneficial for Your Company?
The problem with using bad business write-offs to save on taxes is that successfully saving on taxes ordinarily amounts to spending cash, or accepting new debt. We’re all trying to make a profit. It would seem that saving on taxes would be conducive to this. However, in reality, many tax deductions are only a drain on your income. Some tax deductions can expose your company to greater risk and even can put a firm further behind the eight ball than they were before.
An important point in finance that many people forget, (but the bankers never do) is that money in your hand is worth more than money promised you in the future. This is why lenders are able to make money by charging interest.
Money in the Hand Is Guaranteed.
Money promised in the future is uncertain. Therefore, the dollar in your hand is worth more than the dollar someone vows to pay. Every deduction begins with an expense, in real, in-your-hand capital. You exchange this for an equal amount of possible future compensation at a later time.
Tax laws can change, and the value of the things you write off can also change according to market forces. That means someone could easily come along and say that you do not deserve the amount of compensation for your bad business write-offs that you claim you deserve.
These differentials between what you’re spending and what you expect to get back might not ruffle your feathers right now, especially if you’re a small company who has never been audited. Major international corporations could buy other companies with the amount of money they sometimes lose this way.
Conventional wisdom tells us that all write-offs are good for businesses, but if history teaches us anything it’s that conventional wisdom is not always all that wise.
To find out more about the difference between good and bad business write-offs, get in touch with the professionals at Incompass today. Our business solutions experts are standing by to answer your questions.