Many small businesses are thriving despite high inflation, labor shortages, and other challenges. Unfortunately, some businesses are struggling. Xero’s Small Business Global Index Update for July-September 2023 found that sales are down from a year ago. Even worse, it’s been reported that nearly 1,500 small businesses filed for bankruptcy in the first 9 months of 2023, which is almost as many as in all of 2022. If you look at your profit and loss statement year-to-date and don’t see good numbers, what does this mean taxwise for you?
Year-end tax planning
Businesses in a poor financial position still have time to take actions that can favorably impact their 2023 tax bill. If you find yourself in this position, here are some ideas to help:
Manage inventory wisely. Maybe the holiday season will turn about your profit and loss projections for 2023. There’s limited time to take steps to see that you use your inventory to the best advantage. For example, you may be able to reduce the value of inventory for items that have lost value. This is referred to as inventory write-offs, which is a change to the cost of goods sold. To establish the lower price, offer the items for sale at this price.
Scale back expenditures. While most business-related costs are tax deductible, this doesn’t mean much if you’re in a loss position. Cutting costs can help you move forward while finding ways to increase sales or fees. Every penny counts. Review all expenditures to see where reductions can be taken. Be frugal in upcoming expenditures (e.g., now may not be the year for big bonuses or giving large pay increases).
Avoid added expenditures. Interest rates are at or near all-time highs, so borrowing is a costly action and probably should be avoided or limited…unless essential. This can mean, for example, not buying new equipment now that would need to be financed.
Tax loss rules for pass-throughs
Most small businesses are pass-through entities, which means that owners report their share of profit or loss on their personal returns. Special tax rules apply to business losses.
Limit on noncorporate taxes. Owners are limited in the amount of losses from their pass-through entities that they can deduct on their personal returns. For 2023, the limit on net losses from all businesses passed through to owners is $280,000, or $578,000 for joint filers. More details can be found in the instructions to Form 461. If losses exceed the applicable threshold, the excess amounts are treated as net operating losses, explained next.
Net operating loss (NOL) limits. These losses passed through to owners, in the future, can offset up to 80% of taxable income each year. There’s no limit on the number of carryforward years. Farming businesses can opt to carry a NOL back for 2 years and then forward indefinitely. Find more information about NOLs in IRS Publication 536.
Reduction in QBI deduction. Owners of pass-through entities may be eligible for a personal deduction, called the qualified business income (QBI) deduction, based on business income (profits). But losses from a pass-through entity result in negative QBI. For those with more than one business, negative QBI offsets positive QBI from another business. Remaining negative QBI carries forward to offset future QBI. The instructions to Form 8995 for figuring the simplified QBI deduction have a QBI Loss Tracking Worksheet.
Adjust your final estimated tax payment
Owners make their fourth estimated tax payment for 2023 by January 16, 2024. If estimates were based on higher profits for the year, then reduce the final installment to align with actual profit or loss. Why wait until you file a return to claim a refund and let the government have tax-free use of your money.
If you are struggling, don’t give up.
Vince Lombardi said: “it’s not whether you get knocked down, it’s whether you get up.”
It’s not too late to meet with your CPA or other tax adviser to find other strategies you can use based on your current profit and loss projections. Looking forward to better times.
More information about recession-proofing your business has been published here.