Save while you wait: Net operating loss rules offer tax relief in uncertain economy
Some tax relief may be available for companies that suffer a net operating loss (NOL). This article describes a couple of options available in reporting the loss, along with the circumstances — for example, business structure, cash flow and tax rates — under which one or the other option might be a better choice. A sidebar looks at a couple of year end tax planning issues: 1) a tax credit for hiring veterans and 2) choosing between 50% bonus depreciation and the Section 179 expensing election.
Whether or not the recession is truly over remains up for debate. Some sectors show signs of recovery, but others are still on the lookout for that seemingly miraculous surge. If you count your company in the latter category, some tax relief may be available while you wait for your sector to improve. It can be found in the form of the net operating loss (NOL) rules.
Options to consider
An NOL occurs when a company’s expenses exceed its income, within certain modifications. If your business incurs a qualifying NOL, you have a couple of options. One is to carry the loss back as far as possible under the rules (typically two years), after which you can carry forward any remaining amount up to 20 years to offset future income. The other is to elect to simply carry forward the entire loss. The benefits of either choice depend in part on your business structure. C corporations generally may carry back NOLs to generate an immediate tax refund, boosting cash flow. They can then carry forward any unabsorbed losses to offset income in upcoming years when, ideally, the economy is better and the company more successful. For flowthrough entities, such as S corporations and limited liability companies, an NOL may be used by owners as a tax deduction to offset their salaries and other income. Owners should also assess whether they’ve incurred an NOL at the individual level. An important caveat: The alternative minimum tax (AMT) rules affect most areas of tax planning, and NOLs are no exception. The impact of losses for AMT purposes may differ from that for regular tax purposes. Ask your tax advisor for details.
Often, the prospect of immediate tax relief is what draws business owners toward carrying back an NOL. For example, let’s say a C corporation suffers a $40,000 loss for the 2012 tax year. After careful consideration, its CFO elects to carry back the entire NOL to 2010. The company’s 2010 net income was $8,000, so it could use $8,000 of the loss to offset this income and garner a refund of the tax it had paid on that income. That would then leave $32,000 of NOL to apply to the 2011 tax year and get a refund in the same fashion. The business would then carry forward any remaining portion of the loss to 2013 and beyond until the $40,000 loss was used up or 20 years passed, whichever came first.
If a company’s cash flow is fairly strong, carrying back an NOL to gain an immediate refund or two may not be the best option. After all, carrying forward an entire loss will offset income for up to 20 years. Doing so may be the savvier move when tax rates are scheduled to rise — as they are for individuals (and thus flowthrough entity owners) in 2013 (as of this writing) — or when your business can reasonably project better times ahead. So, getting back to our $40,000 example, that amount represents tens of thousands of dollars that could reduce our exemplar company’s income in years when it might be in a higher tax bracket. Just how many dollars could that save the business? Using $40,000 to offset income for a business in the 35% tax bracket saves the company $14,000. Conversely, an equal loss for a business in the 15% tax bracket would save only $6,000 — a difference of $8,000.
No one likes to lose, and incurring an NOL may seem like a defeat. But, from a tax perspective, there’s a potential bright spot to this financial stumble that could help your company work from a stronger position next year or for many years going forward.
| Sidebar: Hiring and buying
Other year end tax planning issues If your company incurred a net operating loss in 2012, you may not be looking to add employees or buy assets. Maybe things are picking up and the time is right for doing either or both. When it comes to hiring, the federal government is offering a healthy tax break for bringing on board a particular kind of staff member: a qualified veteran. The VOW to Hire Heroes Act of 2011 extended a tax credit for making these hires through 2012. The act also doubled the maximum credit to $9,600 for hiring disabled vets who’ve been out of work for six months or more in the preceding year. In addition, there’s now a credit of as much as $5,600 for hiring nondisabled veterans who’ve been unemployed for six months or more in the preceding year. Another credit, this one for up to $2,400, is available for hiring nondisabled vets who’ve been out of work for four weeks or more, but less than six months, in the preceding year. If you’re in the market for equipment or other business assets, you have a key decision to make in choosing between the 50% bonus depreciation — currently available only until Dec. 31, 2012 — and the Section 179 expensing election. That is, the Sec. 179 election may provide a greater benefit this year because it applies to both used and new property and may allow you to deduct 100% of an asset acquisition’s cost. Bonus depreciation isn’t subject to any asset purchase limit or net income requirement, and Congress may increase it to 100%. Ask your tax advisor for the latest information and for help deciding which break is right for you this year — additional rules and limits apply.
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