Hope and tax change

guest commentary by David Potts

For many small businesses 2009 is a tough year characterized by losses. Not a pleasant circumstance to find yourself. Although I’m reluctant to call it a benefit, to ease the pain you can look forward to some income tax “benefit” due to these losses.

If your business suffers a net operating loss, the Internal Revenue Code allows you to carry this loss back two years and then forward for 20 years to reduce taxable income in those carryback or carryforward years, thereby reducing the amount of income tax paid in those years. A net operating loss is simply an excess of business deductions over gross income (sometimes with modifications). Last year eligible small businesses with losses could elect, at their option, to carry back the loss three, four, or five years rather than the normal two years.

The Worker, Homeownership, and Business Assistance Act of 2009 signed into law last month expanded this election to again carry a net operating loss incurred in 2008 and 2009 back three, four, or five years but this time for most businesses, not just eligible small businesses.

You don’t have to carry back the net operating loss to prior tax years. You can make an election to forgo the carryback period. The decision to carry back your net operating loss or to elect to carry the loss forward requires some planning and analysis. Your objective is to reduce the amount of income tax paid by the greatest amount. For example if you didn’t make much income in the previous years but you expect to be highly profitable next year, you might want to elect to carry the loss forward. The right decision will depend on your particular facts and circumstances.

One advantage to carrying back your net operating loss is to receive a quick cash refund. If you paid income tax in any of the years which you carry back your NOL, the reduction in income tax as a result of the NOL carryback will be refunded. The IRS have procedures to expedite your refund. Individuals can claim this quick refund by completing Federal Form 1045; corporations use Form 1139. The claim for refund cannot be filed before the income tax return is filed. The IRS must act within ninety days of the last day of the month the income tax return is due or ninety days from the date the quick refund claim is filed, whichever is later.

If you are a small business that operates as an S Corporation and are suffering a loss this year, make sure you have enough “basis” by Dec. 31 in your stock and stockholder debt to deduct your loss. Remember that loans to the corporation by banks and finance companies although guaranteed by you won’t count as stockholder debt. The loan must be made directly from the shareholder to the corporation.

If your business is operating as an S Corporation and you have lost money in 2009, but you have no idea of what I am talking about, call your Certified Public Accountant this week. It could be an important call for you.

While you are on the phone with your CPA, discuss the compensation paid by your corporation to you for 2009. Some S Corporations owners still don’t pay themselves a salary. This is a sore spot with the IRS. The reason owners avoid paying themselves a salary is to avoid paying payroll taxes on the money they take out of the business. Instead of a salary they take money from the business as distributions. The IRS position is that you should pay yourself a reasonable salary.

President Obama promised change. He is delivering on his promise. As a consequence the Internal Revenue Code is in flux and it will affect your business and you individually. For many business owners, income tax is one of the largest if not the single largest expense they pay. Planning and preparation is the key to reducing the amount of income tax you pay; the key to keeping more of what you make.

David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow more of his thoughts at ThePottsReport.com. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.

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