A lot of businesses that have experienced nothing but success and growth over the years simply don’t know how to respond to a downturn. For many companies accustomed to nothing but black ink, a loss at the end of the year can come as a real shock.
With a little creative accounting, a loss at the end of the year can actually generate a healthy transfusion of cash for your business! An important (though often overlooked) section of the tax code allows corporations to “carryback” losses and effectively recalculate their tax liability for the previous three years.
If your company paid taxes in any or all of the last three years, the government allows you to carry that loss back and retroactively reduce your tax liability for those profitable years. You could actually recoup every penny of the taxes you paid over the past three years. For a financially-troubled business, this lifesaving maneuver could be money from heaven!
Suppose your company is struggling to keep afloat, but not actually running in the red. Since you don’t have a loss to carry back, you’re out of luck. Or are you?
Let’s say your profitability has plunged to the break-even point after experiencing three successful years during which you paid an average of $25,000 in federal income taxes on income averaging $75,000 annually. With creative tax planning, you might be able to postpone sales until the next tax year, and at the same time accelerate expenses so that you’re able to incur them this year.
Let’s assume further that you’re on the accrual basis of accounting for tax purposes, and that you are able to delay a transaction that will yield $200,000 in gross profit until the next tax year. Additionally, suppose that you pre-pay $50,000 of next year’s operating costs.
Through a little tax planning you would go from a break-even situation this year to one in which you’re able to report a tax loss of $250,000. That loss could then be carried back to each of the three prior years, and your business would be able to recover the entire $75,000 in taxes that you paid to IRS during those years!
There is a catch, of sorts. Carrying back a tax loss can make a business appear financially weaker on paper. Be sure to explain what you’re doing to your banker (see Chapter 35) to protect your credit standing.