Use the Tax Code to Make Business Losses Less Painful
Whether you’re operating a new company or an established business, losses can happen. The federal tax code may help soften the blow by allowing businesses to apply losses to offset taxable income in future years, subject to certain limitations.
Qualifying for a Deduction
The net operating loss (NOL) deduction addresses the tax inequities that can exist between businesses with stable income and those with fluctuating income. It essentially lets the latter average out their income and losses over the years and pay tax accordingly.
Eligibility for the NOL deduction depends on having deductions for the tax year that exceed your income. The loss generally must be caused by deductions related to your:
- Business (Schedules C and F losses, or Schedule K-1 losses from partnerships or S corporations),
- Casualty and theft losses from a federally declared disaster, or
- Rental property (Schedule E).
The following generally aren’t part of the NOL determination:
- Capital losses that exceed capital gains,
- The exclusion for gains from the sale or exchange of qualified small business stock,
- Nonbusiness deductions that exceed nonbusiness income,
- The NOL deduction itself, and
- The Section 199A qualified business income deduction.
Individuals and C corporations are eligible to claim the NOL deduction. Partnerships and S corporations generally aren’t eligible, but partners and shareholders can calculate individual NOLs using their separate shares of business income and deductions.
Prior to the Tax Cuts and Jobs Act (TCJA), taxpayers could carry back NOLs for two years and carry them forward 20 years. They also could apply NOLs against 100% of their taxable income.
The TCJA limits NOL deductions to 80% of taxable income for the year and eliminates the carryback of NOLs (except for certain farming losses). However, it does allow NOLs to be carried forward indefinitely.
If your NOL carryforward is more than your taxable income for the year you carry it to, you may have an NOL carryover. That’s the excess of the NOL deduction over your modified taxable income for the carryforward year. If your NOL deduction includes multiple NOLs, you must apply them against your modified taxable income in the same order you incurred them, beginning with the earliest.
A Limit on Excess Business Losses
The TCJA also established an “excess business loss” limitation, effective beginning in 2021. For partnerships or S corporations, this limitation applies at the partner or shareholder level, after applying the outside basis, at-risk and passive activity loss limitations. Under the rule, noncorporate taxpayers’ business losses can offset only business-related income or gain, plus an inflation-adjusted threshold. For 2023, that threshold is $289,000, or $578,000 if married filing jointly. For 2024, the thresholds are $305,000 and $610,000, respectively. Remaining losses are treated as an NOL carryforward to the next tax year. That is, you can’t fully deduct them because they become subject to the 80% income limitation on NOLs, reducing their tax value.
Important: Under the Inflation Reduction Act, the excess business loss limitation applies to tax years beginning before January 1, 2029. Under the TCJA, it had been scheduled to expire after December 31, 2026.
The tax rules regarding business losses are complex, especially the interaction between NOLs and other potential tax breaks. Contact the office for help charting the best course forward.
Self-Directed IRAs Provide Both Flexibility and Risk
Traditional and Roth IRAs can be relatively “safe” retirement-saving vehicles, though, depending on what they’re invested in, they limit your investment choices. For more flexibility in investment choices but also more risk, another option is a self-directed IRA.
Gaining More Control
A self-directed IRA is simply an IRA that provides greater control over investment decisions. Traditional and Roth IRAs typically offer a selection of stocks, bonds and mutual funds. Self-directed IRAs (available at certain financial institutions) offer greater diversification and potentially higher returns by permitting you to select virtually any type of investment, including real estate, closely held stock, limited liability company and partnership interests, loans, precious metals, and commodities (such as lumber, oil and gas).
A self-directed IRA can be a traditional or Roth IRA. The tax-free growth Roth accounts offer makes them powerful estate planning tools.
Navigating Tax Traps
To avoid pitfalls that can lead to unwanted tax consequences, exercise caution when using self-directed IRAs. The most dangerous traps are the prohibited transaction rules. These rules are designed to limit dealings between an IRA and “disqualified persons,” including account holders, certain members of their families, businesses controlled by account holders or their families, and certain IRA advisors or service providers.
Among other things, disqualified persons can’t sell property or lend money to the IRA, buy property from the IRA, provide goods or services to the IRA, guarantee a loan to the IRA, pledge IRA assets as security for a loan, receive compensation from the IRA, or personally use IRA assets.
The penalty for engaging in a prohibited transaction is severe: The IRA is disqualified, and its assets are deemed to have been distributed on the first day of the year in which the transaction took place, subject to income taxes and, potentially, to penalties. This makes it very difficult to manage a business, real estate or other investments held in a self-directed IRA. Unless you’re prepared to accept a purely passive role with respect to the IRA’s assets, this strategy isn’t for you.
Considering the Option
If you’d like to invest in assets such as real estate, precious metals, or other alternative investments, a self-directed IRA may be worth considering. But it’s critical to understand the risks.
Education Benefits Help Attract and Retain Employees While Saving Taxes
Your business can attract and retain employees by providing education benefits that enable team members to improve their skills and gain additional knowledge, all on a tax-advantaged basis. Here’s a closer look at some education benefits options.
Educational Assistance Program
One popular fringe benefit that an employer can offer is an educational assistance program that allows employees to continue learning, and perhaps earn a degree, with financial help from the employer. An employee can receive, on a tax-free basis, up to $5,250 each year under a “qualified educational assistance program.”
For this purpose, “education” means any form of instruction or training that improves or develops an individual’s capabilities. It doesn’t matter if it’s job-related or part of a degree program. This includes employer-provided education assistance for graduate-level courses, as well as courses normally taken by individuals pursuing programs leading to a business, medical, law, or other advanced academic or professional degree.
The educational assistance must be provided under a separate written plan that’s publicized to your employees and meets specific conditions. A plan can’t discriminate in favor of highly compensated employees.
In addition, not more than 5% of the amounts paid or incurred by the employer for educational assistance during the year may be provided for individuals (including their spouses or dependents) who own 5% or more of the business.
No deduction or credit can be claimed by an employee for any amount excluded from the employee’s income as an education assistance benefit.
If you pay more than $5,250 for educational benefits for an employee during the year, that excess amount must be included in the employee’s wages and the employee must generally pay tax on it.
In addition to, or instead of applying, the $5,250 exclusion, an employer can fund an employee’s educational expenses on a nontaxable basis if the educational assistance is job-related. To qualify as job-related, the educational assistance must:
- Maintain or improve skills required for the employee’s then-current job, or
- Comply with certain express employer-imposed conditions for continued employment.
“Job-related” employer educational assistance isn’t subject to a dollar limit. To be job-related, the education can’t qualify the employee to meet the minimum educational requirements for his or her employment or other trade or business.
Educational assistance benefits meeting the above “job-related” rules are excludable from employees’ income as working condition fringe benefits.
Assistance with Student Loans
Some employers also offer student loan repayment assistance as a recruitment and retention tool. Starting in 2024, employers can help more.
Under the SECURE 2.0 Act, an employer will be able to make matching contributions to 401(k) and certain other retirement plans with respect to “qualified student loan payments.’ The result of this provision is that employees who can’t afford to save money for retirement because they’re repaying student loan debt can still receive matching contributions from their employers.
Tax-Smart Employee Attraction and Retention
In today’s competitive job market, providing education-related assistance can make a difference in attracting and retaining the best employees. Structured properly, these plans can also save taxes for both your business and your employees.
3 Strategies for Estimated Tax Payments
Many individuals today are self-employed or generate income from interest, rent, dividends and other sources. If you’re in this situation, you could be risking penalties if you don’t pay enough taxes during the year through estimated tax payments and withholding. (The due date for the final estimated payment for 2023 is January 16, 2024.)
Here are three strategies to help you pay enough taxes and avoid underpayment penalties:
- Know the minimum payment rules. Your estimated payments and withholding must equal at least:
- 90% of your tax liability for the year,
- 110% of your tax for the previous year, or
- 100% of your tax for the previous year if your adjusted gross income for that year was $150,000 or less ($75,000 or less if married filing separately).
- Use the annualized income installment method, if eligible. This method often benefits taxpayers who have large variability in income by month due to bonuses, investment gains and losses, or seasonal income, especially if it’s skewed toward year end. Annualizing calculates the tax due based on factors occurring through each quarterly estimated tax period.
- Estimate your tax liability and increase withholding if possible. If you find you’ve underpaid your 2023 taxes, consider having the tax shortfall withheld from your salary or year-end bonus by December 31. Withholding is considered to have been paid ratably throughout the year, so this could allow you to avoid penalties, whereas trying to make up the difference with a larger quarterly tax payment could trigger penalties.
Estimated tax payments can be tricky. Please contact the office for help.
Businesses Can Save Taxes by Acquiring and Placing Assets in Service by Year End
Under Section 179 of the Internal Revenue Code, companies can “expense” the full cost of qualifying fixed assets to reduce their taxable income. This means they can deduct the purchase amount currently rather than having to depreciate the asset over many years. Both new and used fixed assets can qualify. The election is available for qualified property placed in service anytime during the tax year.
If you’d like to reduce your 2023 tax liability and are on a calendar tax year, consider acquiring and placing in service qualified assets by Dec. 31, 2023.
For 2023, the maximum overall deduction allowed is $1.16 million (increasing to $1.22 million for 2024). The total asset purchase limit for 2023 is $2.89 million (increasing to $3.05 million for 2024), after which the deduction for the year is reduced dollar-for-dollar until it’s eliminated. You may be able to claim bonus depreciation (80% for 2023, falling to 60% for 2024) on eligible amounts in excess of your Sec. 179 expensing limit.
Make 2023 Annual Exclusion Gifts by Dec. 31
One of the most effective estate-tax-saving techniques is also one of the simplest: making use of the gift tax annual exclusion. It allows you to give to an unlimited number of family or friends cash or property valued up to a “specified” amount each year without owing gift tax or using up any of your lifetime gift and estate tax exemption. For 2023, the annual exclusion amount is $17,000.
The annual exclusion amount is subject to inflation adjustments. For 2024, the amount will increase to $18,000 per recipient. It’s notable because the amount had been stagnant at $15,000 for several years (2018-2021) but, beginning in 2022, it has increased $1,000 each year due to higher inflation.
Each year you need to use your annual exclusion by Dec. 31. The exclusion doesn’t carry over from year to year. For example, if you don’t make an annual exclusion gift to your granddaughter this year, you can’t add your $17,000 unused 2023 exclusion to your $18,000 2024 exclusion to make a $35,000 tax-free gift to her next year. Contact the office with questions.
How QuickBooks Can Improve Your Chances of Budget Success
Budgets are hard to maintain through the best of times let alone over the last few years. First there was COVID. Then supply chain issues. Then a significant rise in inflation. If you’ve been trying to stick to a budget, you’ve probably been struggling.
The biggest challenge, of course, is coming up with realistic target numbers for your budget while building in some flexibility. Second to that is the actual process of getting the numbers into a format you can easily revisit and revise.
We’d like to share some ideas that might help you create more effective budgets. We’ll also demonstrate how QuickBooks can help with the mechanics.
10 Tips for Better Budgeting
Consider these tips as you dig into this critical task:
- Separate your essential from your nonessential expense types. Don’t add the nonessentials until you’ve entered the bills you’ll need to pay and the purchases you’ll have to make during the next calendar year.
- Take advantage of historical data. If you’ve been operating for a while, you can use past financial information to help shape a new budget. And you can do this in QuickBooks:
- Consider your sales cycle. Are you a seasonal business? Then you know when your busy months are. If not, you may still be able to analyze the ebb and flow of your sales.
- Keep it simple – at least at first. Think macro, not micro. You don’t have to include a line item for rubber bands. Too much complexity can cause budget burnout, and your reports will be way too detailed to be as useful as they could be.
- Have an emergency fund. Just as you set aside money for your personal needs, you should build in some backup funding for your business.
- Try to get input from others. If you have employees, consider making them a part of the process. They might be helpful, and it’s good to think about the limitations they might have in specific areas.
- Overestimate, rather than underestimate. If you’ve ever tried to work within a budget, you may have had to “borrow” from one category to make up for a shortfall in another. Try to avoid this by setting realistic goals.
- Pay down debt with any excess funds. Debt costs money. If you come up with some extra dollars once your budget needs are satisfied, consider applying it to outstanding debts. Start with the ones that have the highest interest rates.
- Take a hard look at your suppliers. Can you find less costly alternatives for the goods and services you have to purchase to keep your business going?
- Revisit your budget on occasion. Analyze how your budget is working monthly. In fact, start budgeting for a couple of months at a time. It won’t be as intimidating, and you’ll catch problems early. QuickBooks allows you to modify budget amounts as you learn how well your estimates are working:
Building Your Framework
Let’s look at QuickBooks’ budgeting tools. Open the Company menu and click Planning & Budgeting | Set Up Budget. The Budget field in the upper left should default to the next fiscal year (Profit & Loss by Account). Click Create New Budget in the upper right. Change the year if you need to, then click Next. Leave no additional criteria selected and click Next.
Make sure Create budget from scratch is selected on the new page, then click Finish. Your empty budget will open, containing income and expense types taken from your Chart of Accounts, like Insurance Expense, Office Supplies, and Meals and Entertainment. The only way to modify those categories is by changing your Chart of Accounts, which you should only do with professional supervision.
Now comes the hard part. You’ll have to start estimating your monthly budget amounts and entering them in QuickBooks’ budget template. The software offers two tools to help with this. If you anticipate the costs to be the same every month, like your internet access charges, enter that number in the first column, then click Copy Across. That number will appear in every box.
If you want to have QuickBooks increase or decrease the number every month, click Adjust Row Amounts and indicate your preference in the small window that opens:
When you’re finished working on your budget, click Save.
Evaluating Your Progress
QuickBooks makes it easy to see how well you’re adhering to your budget by providing four insightful reports: Budget Overview, Budget vs Actual, Profit & Loss Budget Performance, and Budget vs Actual Graph. These are fairly self-explanatory, but if you want some help analyzing the trouble spots in your budget, contact the office.
Upcoming Tax Due Dates
Corporations – Deposit the fourth installment of estimated income tax for 2023. A worksheet, Form 1120-W, is available to help you estimate your tax for the year.
Employers – Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in November.
Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in November.
Employees – who work for tips. If you received $20 or more in tips during December, report them to your employer. You can use Form 4070.