One of the unfortunate realities of operating a business is that you might not always make the money you anticipated. Whether you’ve only recently started your business and have not earned back your initial investment, or you’re dealing with problems related to the larger economy, earning a profit isn’t always possible. In fact, for businesses in these situations, it’s fairly common to be operating at a loss.
Because this situation is so common, there is a provision in the tax code that allows business owners, especially sole proprietors, to receive a quick tax refund by claiming a net operating loss. In short, this is what you have when your losses are greater than your combined income from all sources, and while it sounds bad—and certainly isn’t pleasant to experience, given the fact that your business is losing money—claiming a net operating loss actually provides some relief by lessening your tax burden.
Claiming a net operating loss allows business owners to receive a partial or even full refund of taxes from previous years. Even better, this refund may often be made relatively quickly, which means business owners benefit from receiving much-needed funds when they can actually use them.
Calculating your net operating loss
Determining whether your business has a net operating loss, and in what amount, may be more complicated than you’d expect. For sole proprietorships, if your listed expenses are greater than your income, you have a net operating loss. For other types of businesses, such as partnerships, LLCs and S corporations, business losses are deducted from your income along with any other deductions. In other words, they are factored in when determining your adjusted gross income. If your adjusted gross income is a negative number after all of your deductions have been factored in, your business can claim a net operating loss.
You have two options when it comes to applying your net operating loss to your taxes. You may either apply it to previous tax years or to future tax years—carrying the loss back or forward, in IRS parlance. In general, carrying the loss back allows you to benefit from a quick refund, while carrying the loss forward allows you to reduce your tax liability in future years. The best option depends on a number of factors, including how much tax you’ve paid in the past.
Because the process of claiming and benefiting from a net operating loss can be complex, it’s best to seek the input of an experienced and knowledgeable business attorney as soon as possible if you’re interested in proceeding. By leveraging the provisions for claiming net operating losses, you can help your business find stronger footing sooner, and hopefully begin earning a profit in the months to come.
Adam N. Marinelli is an attorney in the Civil Litigation Practice Group at BoltNagi PC, a full service business law firm serving the U.S. Virgin Islands.