A failed business can leave its ownership with mountains of unsettled debt and tax obligations. The IRS provides specialized tax deductions to allow a struggling company to offset its early losses and reduce tax liability over several years. A failed business with heavy losses can lean on these tax deductions to reduce the burden on owners who've already lost significant investment money.
Net Operating Loss Definition
A net operating loss occurs when your business has more tax deductions than taxable income. This is probably the case if your business has failed or is headed toward financial collapse. You can use your business' net operating loss as a tax deduction to reduce your overall tax liability if your company is a sole proprietorship or a C-corporation. According to Lawyers.com, a business partnership, limited liability company or S-corporation cannot use a net operating loss as a tax deduction on a federal return.
Pay-Forward and Pay-Back Rules
The IRS does not allow you to claim a tax deduction for a net operating loss in the same tax year your business incurs the loss. Instead, you may either pay the deduction forward or backward. This allows you to use the losses of your failed business to retroactively reduce your tax liability or reduce your liability in a future tax year. Applying the operating loss to a previous tax year can help eliminate any taxes you still owe the IRS. Using the deduction in a future tax year helps reduce any tax liability from the sale of business assets once your business officially closes.
If your business is a sole proprietorship, the IRS restricts your ability to claim deductions when determining your company's net operating loss. According to Lawyers.com, you cannot legally include exemptions for yourself, your spouse or dependents when determining the net operating loss of your business. Additionally, you cannot include any gains or losses from capital investments, personal deductions for medical payments or court-ordered alimony or net operating loss deductions from previous years into your current net operating loss numbers.
Corporation Tax Rules
A dissolving corporation's tax rules for determining a net operating loss are different than a sole proprietorship. The IRS does not allow a corporation to use a domestic product activities deduction when determining a net operating loss. A corporation can use a deduction for dividends paid to investors on preferred stock without limit to its taxable income for the year and can also take deductions for dividends received from investments without regard to the normal aggregate limitations.
- Lawyers.com: Tax Deduction for a Net Operating Loss
- IRS.gov: Deducting Business Expenses
- Internal Revenue Service. "About Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts." Accessed Feb. 10, 2020.
- Internal Revenue Service. "2019 Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts," Page 2. Accessed Feb. 10, 2020.
- Internal Revenue Service. "2019 Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts," Pages 4-5. Accessed Feb. 10, 2020.
Jonathan Lister has been a writer and content marketer since 2003. His latest book publication, "Bullet, a Demos City Novel" is forthcoming from J Taylor Publishing in June 2014. He holds a Bachelor of Arts in English from Shippensburg University and a Master of Fine Arts in writing and poetics from Naropa University.