Very few businesses can count on profit stability from one tax year to the next.
Although it would be nice to be able to depend on the same amount of profit each year, a more likely scenario is that you will have a year or two of profitability followed by a down year in which the company experiences a net loss.
A business with volatile year-to-year profitability creates unique tax challenges. This year's feast results in a high tax burden that could have been reduced by averaging in the impact of next year's famine. The tax implications can be particularly acute in companies that experience multiyear business cycles.
Contrary to popular opinion, the IRS isn't completely insensitive to the needs of business owners. They understand the unpredictability of busines as well as the reality of long-term business cycles. Consequently, they make allowances for using this year's business losses to lower taxes in previous years. There are conditions and restrictions to carryback provisions, but if you're taking a hit this year, you may be able to use the loss to reduce your tax burden in prior years.
Tax Loss Carrybacks
A tax loss carryback makes it possible for some companies to offset previous year's earnings with this year's losses. Here's how it works: Businesses can typically elect to either apply net operating losses in the current tax year to the previous two year's operating gains or carry the loss forward to future tax years. In 2009, federal law temporarily expanded the carryback option for small businesses, allowing companies with gross receipts less than $15 million to carryback losses to the previous five years.
The election of a net operating loss carryback is irrevocable and can limit your company's ability to use current losses to offset gains in subsequent tax years. But even if you choose not to apply operating losses to prior years' gains, you still have the option of amending your tax returns for the previous three years to include any expenses or deductions you may have neglected at the time of the initial filing.
Capital Loss Carrybacks
Corporations also have the opportunity to carryback current capital losses to offset capital gains that were realized in previous tax years. A corporation can carry back a capital loss for three years and carry forward capital losses for five years. But here's the catch: Capital losses can only be used to offset capital gains. Businesses can't use capital losses to reduce net operating income, so you'll need to rely on other strategies to reduce the tax burden associated with normal operations.