Although no one plans for a loss, many of the retailers catering to the tactical market do, or should, “plan” to minimize the effect of potential losses, reverse them more quickly and, in some cases, reap the benefits of increased cash flow and lower tax bills today and in the future.

Whether the result of the economy, competition or events outside the control of the business’s owner or manager, losses are almost inevitable. Thanks to our tax laws, however, planning for losses, whether past losses or anticipated losses, can help every tactical retailer ease the bite of those losses, recover faster and, in many cases, reap tax breaks. 

Ensuring applicable tax treatment — and a lower tax bill — for losses should begin now, well before any loss occurs. Consider, for example, typical, everyday losses.

Operating Losses

While lost profit is not actually a loss, an unpaid invoice might be. In fact, it may be possible to write unpaid invoices off on the annual tax return. Unfortunately, these losses are available only to those retailers using the accrual method of accounting, where the invoice amounts were already included in the operation’s gross income.

Business bad debts, on the other hand, are often labeled as losses. Regardless of whether the business bad debt arose from an owner’s loans to his or her business, or from loans to others, so long as they are business-related, they can be deducted to the extent of their worthlessness. Unfortunately, business bad debt deductions are not available to shareholders who have advanced money to a corporation as a contribution to capital, or to creditors who hold a debt that is confirmed by a bond, note or other evidence of indebtedness. 

There are also those losses that can be controlled. Quite simply, a loss is allowed for the abandonment of an asset. If a depreciable business asset or an income-producing asset loses its usefulness and is subsequently abandoned, the loss is equal to its adjusted basis. Obviously, an abandonment loss must be distinguished from anticipated obsolescence. 

Best of all, this type of loss applies to the abandonment of a business, as well as the abandonment of intangible assets, such as contracts for services. 

Inventory losses, casualty and theft losses not covered by insurance, and losses on the sale of business assets may also be deductible. Losses occurring from fire, storm, shipwreck or other catastrophic events are clearly tax-deductible. Of course, casualty losses must be due to a sudden, unexpected or unusual event in order to qualify as a tax deduction. 

Casualty losses, at least if they are the result of a legitimately declared “disaster,” can be utilized to recoup taxes paid in the previous tax year. In essence, a casualty loss resulting from a declared disaster may be claimed as a tax deduction in the year preceding the year in which the disaster actually occurred. This allows the retailer to amend its prior year tax returns and receive an immediate refund as a measure of relief.

The owners and operators of many troubled businesses have discovered the advantages, yes, advantages of big-time losses.

Net Operating Losses

A Net Operating Loss (NOL) occurs when a business’s deductions exceed its taxable income or adjustable gross income. ln other words, when it hasn’t been making enough profit to overcome expenses. Depending on how much of a loss it sustains, the business can benefit from the negative income for a prolonged period of time until it becomes profitable again.

A NOL is the total excess of allowable deductions over gross income, with required adjustments. Thus, if all of the retailer’s expense deductions exceed the income shown on the tax return — or the owner’s return — there may be a NOL. 

Owners of an unincorporated business — a sole proprietorship, partnership or limited liability company (LLC) — can claim their business operating losses on their annual individual tax returns. Currently, NOLs can no longer be carried back to offset the taxable profits in earlier years. They can, however, result in lower tax bills down the road. 

NOLs can now be carried forward indefinitely, although they are limited to a maximum of 80% of the retailer’s upcoming year’s taxable income. A 20-year limit applies for losses that occurred prior to the 2018 passage of the rule.

Too Much Loss

A number of unfortunate business owners, particularly those whose businesses operate as pass-through entities, have discovered that there can be such a thing as too much loss. The Tax Cuts and Jobs Act continues to restrict the amount of losses a sole proprietor, partners, S corporation shareholders and lLLC members, can currently deduct.

If a pass-through business generates a tax loss in 2024 or 2025, it cannot deduct an “excess business losss.” An excess business loss is the excess of the retailer’s total deductions for the tax year over the sum of the aggregate business income and gains for the tax year, and $250,000 ($500,000 for taxpayers filing jointly).

The excess business loss is carried over to the following tax year, where it is deducted under the NOL rules.

For those business losses passed through to individuals from S corporations, a pass-though partnership or an LLC that is treated as a partnership for tax purposes, the excess business loss limit applies at the owner level. In other words, each owner’s allowable share of business income, gain, deduction or loss is passed through to the owner and reported on his or her personal federal income tax return.

It should be kept in mind that the excessive business loss limits apply after applying the Passive Activity Loss (PAL) rules. The PAL rules prohibit taxpayers from using passive losses to offset earned or ordinary income.

Losses From Passive Activities

The tax rules are pretty clear: Ordinary losses can only be deducted against ordinary gains, and capital losses can only be deducted against capital gains. Since most people usually have much more ordinary income than capital gains, ordinary losses are usually more useful than capital losses in reducing taxable income.

Passive activities are those in which the owner or shareholder doesn’t materially participate. Material participation is generally defined as being involved in an activity on a regular, continous and substantial basis. Under these rules, passive activity losses that exceed income from passive activities are disallowed for the tax year, although they can be carried forward to the next tax year, where they face the same passive loss rules.

Essential Planning Essentials

Planning to cope with anticipated and unplanned for losses begins with the key types of losses recognized by the IRS. The tax rules allow deductions for ordinary losses from ordinary income. This reduces the amount of taxable income and reduces the income tax bill.

Capital gain, on the other hand, is the profit received when property is sold other than in the ordinary course of business. Capital losses arise when that kind of property is sold at a loss. 

The sale of publicly traded stock (such as shares of IBM) by someone other than a stock trader is an example of capital gains and losses. Deducting capital losses against capital gains reduces the amount of taxable income, thus reducing the amount of income taxes.

Owners of unincorporated businesses who sell or liquidate their businesses at a loss are allowed to deduct those losses against their ordinary income. Owners of corporations who sell or liquidate their corporations at a loss are required to deduct those losses against their capital gains. 

If their capital losses exceed their capital gains, they are allowed to divide the loss into increments of up to $3,000 per year and deduct that amount against their ordinary income. At that rate, depending on the amount of the capital loss, it may be many years before the entire loss is deducted.

Loses

Many business owners and managers are discovering that tough times mean making the most out of a bad situation by utilizing the tax laws to reap benefits from those losses. Whether as a result of economic conditions, competition, or factors outside the control of the operation’s owner or manager, every retailer is at risk of losses. Planning can help every retailer reap favorable income tax deductions which may, in turn, ease the risk of failure.

Under our present tax rules, any loss sustained during the taxable year or a loss not covered or “made good” by insurance can be claimed as a tax deduction. Would a refund on taxes paid by the formerly profitable business in years past help ease the pain of lingering losses this year? What if last year’s business losses could offset next year’s profits and reduce the tax bill for years to come? All this, and more, is possible with proper loss planning.