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Does Your Small Business Have a Net Operating Loss?

In the current economy, it’s safe to say that many small businesses might have chalked up a net operating loss during the last year or two. If that’s the case, the Virginia Society of CPAs advises that there is one potential tax deduction that you should not miss. But it may be necessary to call in an expert to determine if you are eligible.   

Calculating a loss

Determining whether you have a loss is easy: you simply add up the income your company earned and the expenses it paid. Subtract the expenses from your income. The balance is the taxable income for the year.

Enter the net operating loss

What happens if the money you spent in running your business is greater than your business income? In this situation, the business is considered to have a net operating loss. Generally, individuals who are sole proprietors of a business can use net operating losses. S corporations and partnerships cannot, but their shareholders or partners may be able to apply the net operating loss to their own individual net operating losses.

What constitutes a net operating loss?

There are several kinds of losses eligible to calculate a net operating loss. They must be a result of excess expenses related to a trade or business. The net operating loss may also include the following losses or deductions: casualty or theft losses; expenses for moving to a new job location; your share of partnership or S corporation operating losses; or rental property losses. Personal expenses, capital losses and tax exemptions are examples of what you cannot deduct to calculate your net operating loss.

A simple example

Your business earned $100,000 last year. However, that was a drop from your past earnings due to the rough economy. Your expenses for running your business during the year were $150,000 — the amount spent in the past when the economy was in better shape and your sales were higher. On the 2009 tax returns, you would be able to deduct your losses. However, since you lost $50,000 more than you made, you may be able to use those additional losses in other tax years, deducting them against your past or future earnings as a net operating loss.

Putting it to work

This process may seem simple, but there are complicated rules on how to apply them including a list of expenses and deductions that don’t count toward the net operating loss. As a general rule, it’s useful to remember that they are called net operating losses for a reason. Any expenses not related to the operation of a business probably will not apply.

Carry back or carry forward?

What happens if you do have a net operating loss? There are complicated rules involved in answering that question. The rules help determine in which years the net operating loss can be applied. Generally, you would begin by applying your losses to your previous two years’ tax returns, although this rule can be waived under certain circumstances. If losses remain after you’ve applied your net operating loss to your two previous years’ income, you can then carry forward the losses for up to 20 years after the original net operating loss occurred. For net operating losses arising in 2009, you can elect to carry the loss back for three, four or five years (instead of the normal two years). However, there are complicated rules to be followed to do this.

Your CPA can help

If you’re uncertain about whether your company qualifies as having a net operating loss, or about any tax issue facing your business, remember that your CPA has the expertise to offer the advice you need. He or she can also help you decide how to navigate an uncertain economy or work with you on your business or personal financial planning issues. Turn to him or her for trusted business advice whenever you need it.

The Virginia Society of Certified Public Accountants (VSCPA) is the leading professional association dedicated to enhancing the success of CPAs. Founded in 1909, the VSCPA has 9,000 members who work in public accounting, industry, government and education. For general information, please visit the Press Room on the VSCPA website at www.vscpa.com, e-mail vscpa@vscpa.com or call (804) 612-9424. To search for a CPA in your geographic region, visit www.financialfitness.org and click on “Find a CPA.”

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