Welcome to Selfmade Finance School, our new money series with Block Advisors to help small business owners with their tax, bookkeeping, and payroll needs year-round. This week, we're shedding light on P&L statements and how to assess business losses for tax purposes.
As we all know by now, 2020 was a rough year for so many. Many business owners who had thriving businesses were stunned by the impact of the pandemic. While there was some government relief, in many cases, it simply hasn't been enough to keep businesses in the black. So, what if you had a year where you didn't make a profit? Does this mean you don't have to file taxes? The answer is a big fat NO. You still need to file. Also, you want to file. Today we will break down the impact of losses on your business and why they are important to record.
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The Importance of a P&L Statement
The first thing you need to do is get a handle on the financial health of your business in a real, detailed way. The easiest way to do this is using a profit & loss statement (P&L). This document is a good gauge of a small business's financial condition because you can use it to gain insights about your operations and identify new opportunities for growth. A P&L statement details a business' revenue and expenses over a period of time (most likely the calendar year). You can also make a quarterly P&L which would be helpful to you if you pay quarterly taxes. A P&L statement is often referred to as an income statement. If the statement reveals that your revenue is higher than your expenses, your business is profitable; if the reverse is true, you are running your business at a loss. If you are looking for examples of P&L statements, I suggest looking online for examples by searching for your specific type of business. Each business's P&L statement will be slightly different based on the type of business they do.
If you have done the work and have determined that you generated a loss in 2020, you now need to understand what that means for your tax filing. If you are a sole proprietor running an active trade or business, you may deduct any loss your business incurs from your other income for the year. This income could be from another job, investment income or from a spouse's income. If your business is set up as an LLC, an S-corporation or partnership and you materially participate in the business, then you may deduct a business loss. If your losses exceed your income from all sources for the year, you have a "net operating loss" (NOL). You may be able to take all or part of your business loss for a year to offset other income, to reduce your overall taxes. However, the total amount of your loss may be limited in one year. In that case, you may be able to take that loss in a previous year (called a loss carryback) or a future year (called a loss carryforward).
"At Block Advisors, we create a profit and loss summary for our small business clients as part of their tax prep, then we review it with them to talk through what the numbers really mean," said Marcie Rahn, Enrolled Agent and Certified Master Instructor at Block Advisors. "So many small business owners don't regularly look at their variable costs or understand how to optimize their profitability within their industry. The P&L review has been extremely valuable to our clients."
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Tax Changes and Business Losses
In 2017/2018, we saw sweeping tax reform that impacted business losses. These reforms limited the amount of losses you could take in a calendar year and removed the ability to carry back the losses. However, with Covid, the government loosened the NOL (net operating loss) rules to ease the burden on businesses that were affected by the pandemic. These changes impact business losses in 2018, 2019 and 2020. Therefore, for this year's filing, I implore you to engage with a tax professional before trying to do this on your own. Block Advisors small business certified tax pros can be found in nearly 8,000 Block Advisors and H&R Block locations nationwide, or you can connect with them virtually.
The CARES Act allows small businesses (not corporations) to file an amended tax return for 2018 and/or 2019 if your business losses were limited for those years. It also allows businesses to carry back NOLs from 2018, 2019 and 2020 to the five previous years. Finally, the CARES Act allows small business owners to use net operating losses to offset your personal income with no limit.
"If you had a NOL in 2018, 2019 or 2020, then you may really benefit from the 5-year carryback provision…OR you may not! If you want to forego the carryback, then you've only got until the due date of your 2020 tax return to make that election. If you want more time to make that decision, then please file an extension. That will give you until October 15 of 2021 to get professional advice and decide what's best for you," said Rahn.
The bottom line is that if you have generated a loss this year, it may help you at tax time. This article is just a high-level introduction to the CARES Act loss provisions, so be sure to engage with a tax professional who understands the current tax relief program so that you can take full advantage of the tax benefits this year.
*All details were sourced from IRS.gov and blockadvisors.com