Losing out on losses is only the IRS’s gain.
As one of the most valuable things a company can use to maintain and grow, losses are one of a business accountant’s best tools. Not only do they help reduce your tax liability, but they also can help open up spending power, as well as become useful for growth strategies. Considerably the biggest factor that keeps some industries thriving, losses are one of the biggest keys to keeping a steady flow of capital. Here’s what you need to know:
Losses are one of the most powerful accounting tools a business has.
Industries like real estate, investment, insurance, and nonprofits rely heavily upon losses to help keep an honest assessment of how much cash they have on hand, as well as prove to the IRS. In many ways, losses are a core driver to economic growth; for example, a real estate developer is more likely to have their cash and credit tied up into properties, which is partly why they’re able to write-off so much. The name of the game is reducing your tax liability from what you’re already spending for current and future years.
The biggest changes to losses came from the 2017 Tax Cuts and Jobs Act, which outlined the following:
- Noncorporate taxpayers may be subject to a cap on business losses of $250,000 (or $500,000 if it was a joint return).
- Most operating losses can only be carried forward. For losses after 2017, the net operating loss deduction is limited to 80 percent of taxable income.
- Meals and beverages can be deducted by 50 percent, as long as the meal isn’t considered lavish or extravagant.
- Finally, fines, penalties, and payments made in sexual harassment/abuse cases can’t be deducted.
Overall, your day-to-day can see a lot more losses to reduce your liability than imagined. Everyday items like your cellphone, internet, transportation, and partial rent are losses. Take a gander through your bank statements to see what might be a loss for you, as our goal is to come up with what’s reasonable in the eyes of the IRS for your business.
Net Operating Loss
An important term to know when talking about losses is Net Operating Loss.
Net operating losses occur when a business tax deductions are more than its income. The IRS gives a tax credit for this, which can offset future profits. Especially helpful for new businesses that are trying to grow, net operating losses can be a lifesaver. Furthermore, they’re one of the most helpful tools if you experience a natural disaster, theft, moving expenses, or property damage. While seen in more small businesses than individuals, net operating losses are helpful in reducing your liability by using a loss carryforward.
Losses are often about needs for growth, which is why they’re such a useful tool to keep in your belt.
How A Loss Carryforward Works
As we noted above on the Tax Cuts and Jobs Act, most losses now can only be carried forward (not backward). While previously a loss this year could retroactively effect previous tax liability, the rule is now that net operating losses can only be applied to the future.
For example, let’s say that I bought a new building in 2020 for my business that cost $500,000. After my taxes, if I have a net operating loss credit of $100,000, I can apply that credit to my future liabilities in taxes for 2021, 2022, etc. This helps establish spending power for upcoming years, as well as simplifies tax liability after the credit is established. Building up losses to carry forward is how some people reduce or completely eliminate how much they have to pay in taxes year after year.
How Deferred Tax Assets Work
A deferred tax asset is when a business overpays, pays in advance, or has a carried forward credit from losses on their taxes. When given a refund, an overpayment is considered an asset to the company. This doesn’t count as income, which can be helpful in creating a method for reducing liabilities.
In the simplest terms, this is when an asset has a reduction in value due to market factors. For example, if the US government banned all electronic cigarettes and vaping, then the value of those components owned by the likes of JUUL or Phillip Morris would have to adhere to what’s in demand internationally, which could be less than what’s in the US. This means the electronic cigarette components are impaired assets, which would count as losses due to the current demand for their asset.
Losses can help quite a bit in our perception of how we spend our businesses’ money.
While spending to incur losses should be reviewed on a case by case basis between how much it appreciates versus depreciates (for example, an appreciating asset like real estate might be wise, while buying a whole fleet of trucks that would depreciate over time might not). Losses are often about needs for growth, which is why they’re such a useful tool to keep in your belt. As it’s all about reducing liabilities, losses are the best way to see those gains.
Want an accountant that supports your mission?
Your financial wellbeing is only part of the equation. Stand firm knowing your accountants back your organizations values, goals, and team, too.