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How Business Losses Affect Your Tax Return

Many businesses may have incurred a loss in 2020 due to the pandemic-induced economic slowdown. When expenses exceed revenue, a loss is generated. How these losses affect your business tax return depends on many factors.

CARRYBACK OR CARRYFORWARD

Under the CARES Act, businesses that incurred a loss for 2020 can carryback that loss five years. That means an amended tax return would need to be filed. Carrying back the loss could result in a refund of taxes paid in prior years.

However, if carrying back the loss won’t benefit you, because your business already had a loss, then you can carry the loss forward indefinitely to offset income in future years.

Note that carrying back losses will not be an option for 2021 as the rules return to pre-CARES Act standards, which do not allow carry backs. Any loss for 2021 can only be carried forward. And there are limits to the amount of the loss that can be used in future years.

EXTRAORDINARY LOSSES

Business losses are not limited to operating losses. Businesses that incur extraordinary losses can also claim these on tax returns. Losses for things like fires and natural disasters can generate a loss for your business. Any insurance proceeds received from a loss will reduce your deduction.

Tax implications for business losses can be tricky. Speak with your tax professional to ensure your loss is calculated correctly.

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2020 Tax Changes

2020 has been a big year for tax law changes. The SECURE Act is the most significant retirement reform law in at least a decade. The CARES Act provided tax breaks designed to help ease the economic burden of the Coronavirus and related shutdowns. These are just a few of the many changes affecting individuals this year:

  • The SECURE Act raised the required minimum distribution requirement (RMD) for traditional IRAs from 70½ to 72 for anyone turning 72 in 2020 or later. Then, the CARES Act suspended RMDs for 2020 without penalty.
  • Traditional IRA owners can now continue to make contributions past the age of 70½.
  • If you were impacted financially by COVID you can take higher than normal distributions from your retirement account this year — up to $100,000 — without penalties. You have three years during which you can pay the income taxes on the distribution or repay the money to the plan. Plan loan repayments are also delayed for one year.
  • Early withdrawal penalties on IRAs and 401(k) distributions of up to $5,000 are also waived for households with a new baby, including adoptions. Income tax is still due.
  • Effective in 2020, non-spousal heirs can no longer stretch IRA distributions over their lifetimes. Instead, funds must be distributed within ten years of the original owners’ death. (Some exceptions apply.)
  • The CARES Act suspended the limit on deductions for cash donations by people who itemize (gifts to donor-advised funds and private nonoperating foundations are excluded). A new “above-the-line” deduction for cash donations of up to $300 is available for nonitemizers.

As we head into the final quarter of 2020, now’s the time to schedule a year-end tax review. Some of these tax opportunities expire at year-end.

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Client Profile

Nicole has been furloughed from her job at a major hotel chain. Her temporary suspension is scheduled to last through August at least. How does this affect her income and benefits?

Nicole can apply for unemployment benefits. Thanks to the CARES Act, she will receive a $600 weekly benefit for all weeks of unemployment between April 5, 2020 and July 31, 2020, in addition to the amount she is entitled to receive under state law.

As a furloughed employee, Nicole may or may not still be eligible for her employer-sponsored benefits, including health insurance. No general rules apply to every situation, as all circumstances are somewhat unique. She should reach out to her human resources department to determine if any changes have been made to her employee benefits.

To help manage her money until then, if Nicole has debt, such as student loans or a mortgage, she should consider the debt forbearance programs made possible by the CARES Act, which suspends payments between March 13, 2020, through Sept. 30, 2020.

Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.

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CARES Act Retirement Plan Changes

The Coronavirus Aid, Relief, and Economic Security (CARES) Act offers relief to individuals with some major changes to retirement plans in the near-term. These temporary new rules apply to both current retirees and those saving for future retirements.

RMDs SUSPENDED FOR 2020

Under normal circumstances, individuals with IRAs or 401(k)s who are over the age of 72 must take required minimum distributions (RMDs) each year.* Your RMD is calculated by the life expectancy factor assigned to your age, then divided by your retirement plan’s account balance from December 31 of the prior year.

The CARES Act, however, has created a provision that lifts RMDs for 2020. Depending on your tax bracket, it may or may not make sense to take out the money.

EARLY WITHDRAWAL PENALTY ELIMINATED

Tapping retirement funds is something we should all try to avoid, but sometimes circumstances leave us no choice. That is why the government has waived penalties when you take out an early distribution from an IRA or 401(k) before retirement age. While income tax is still due, the 10% penalty is removed for any distribution up to $100,000 from January 1, 2020 to December 31, 2020. This is meant to help with cash flow for those who have been financially impacted by the pandemic.

HIGHER 401(k) LOAN LIMITS

If you have been impacted by COVID-19 in some way, you may qualify for a larger 401(k) loan amount. Typically, you can borrow up to $50,000 or half of your balance amount. Between March 27 and December 31, 2020, however, you can borrow up to $100,000 or 100% of your 401(k) account balance, if less, as part of the CARES Act provisions.

Qualifying circumstances include you, your spouse, or dependent being diagnosed with COVID-19 or financial consequences from the pandemic like losing your job. Consult your tax advisor on how to qualify and what type of certification you need.

*Age 70 is a new age limit effective 2020.

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Make Sure Your Loan is Forgiven – Update

Updated on June 8th – On June 5th, President Trump signed into law the Paycheck Protection Program Flexibility Act of 2020, which amends the Small Business and CARES Act. This action provides more time for borrowers to qualify for loan forgiveness and eases the restrictions on how much of the forgivable portion of the loan proceeds must be used for payroll costs. Below are the noteworthy changes that affected the original article: 
 

  • Loan Maturity Date Extended. Borrowers now have five years, up from two, after the forgiveness period to repay any portion of loans that were not forgiven. Also, the deferment period is extended from six months to the date the borrower’s forgiveness amount is determined.
  • Eligibility Restrictions on Forgivable Expenses Eased. Borrowers now have 24 weeks from the loan origination date or until December 31, 2020 to qualify for loan forgiveness, which is extended from eight weeks. Loan application deadline remains June 30, 2020.
  • Deadline Extended for Measuring FTE and Salaries. The deadline to fully return Full Time Equivalent “FTE” headcount and salaries to February 15, 2020 levels, has been extended to December 31, 2020. This deadline must be met in order to eliminate the reductions for loan forgiveness. There is are two exceptions: The first is when the borrower is able to document an inability to rehire individuals or inability to hire similarly qualified employees for unfilled positions. The second exception is when the borrower cannot fully operate due to inability to meet safety standards for employees and customers.
  • Payroll Cost Allocation Reduced. For loan forgiveness, 60% of the loan must be used for payroll costs, which is down from 70%. The legislation also clarified that borrowers can defer 50% of the employer’s share of payroll taxes until 2021 and the remaining 50% until 2022.

Make Sure Your Loan is Forgiven

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided for small businesses to receive low-interest loans under the Paycheck Protection Program (PPP). At this writing, Congress is considering additional billions in funding to replenish the depleted program. Meanwhile, here is an overview of the program.

WHO CAN APPLY

Loans may be available to businesses with fewer than 500 employees that were in operation on February 15. This includes not-for-profits, veterans’ organizations, Tribal concerns, self-employed individuals, sole proprietorships, and independent contractors. According to the SBA and Treasury, some businesses with more than 500 employees in certain industries also can apply for loans.

Specific loan amounts are calculated as two months of a company’s pre-coronavirus average monthly payroll costs plus an extra 25%. The PPP loans have a 1% interest rate and a five-year repayment term, which is deferred for the first six months.

LOAN FORGIVENESS

The loan may be fully, or partially forgiven provided the company appropriates at least 60 percent of the loan to cover payroll, including benefits costs, within eight weeks. Additionally, not more than 40 percent of the loan may be attributable to nonpayroll costs, including mortgage interest, rent and some utilities.

If you reduce your staff or their wages, the rate of forgiveness on your loan lowers – meaning you will be on the hook to repay ineligible funds. Business owners must rehire any laid off employees by December 31 and must keep at least 90% of their original staff on the payroll through at least September 30.

Before applying for the Paycheck Protection Program, consult with your tax advisor to make sure you can feasibly meet all of the requirements within your current business outlook and that you fully understand the rules. Keep in mind that if you are unable to meet every requirement perfectly, your loan may not be forgiven and you will be responsible to pay it back within five years.