As you do your small business income taxes, you may find that your company actually failed to show a profit. Should you be discouraged? Not at all. There are several reasons not to let this bother you. Here are a few of the most important ones.
New businesses commonly fail to show a profit consistently when they're getting on their feet. You often have to pay significant start up costs, seek out early clients, accounting services, and build a product line or reputation. All these things eat into any earnings you get.
The IRS recognizes this challenge, allowing new businesses up to five years to show a consistent profit before even questioning their statues as a company. Even beyond these parameters, you can still be labeled a for-profit company if you're actively trying to earn a profit. So don't take it personally if you aren't in the black every year.
It's a Paper Loss
Income tax filings are not quite the same as business financials statements and bank accounts. The rules are slightly different for income taxes and include items that may not directly affect your day-to-day financials.
For instance, the IRS allows you to deduct depreciation on assets. Depreciation is the reduction in the value of an asset over time. If you deduct depreciation on a high-value asset on your taxes, you may even find that it wipes out your profit — but only on paper.
Losses are Useful
Even if you do spend more than you earn — on paper or in real life — you can benefit from this. A net operating loss (NOL) can be used to reduce income taxes in surrounding years.
If you earn $100,000 but spend $150,000, you have a NOL of $50,000. You don't pay taxes on this income due to the loss. But you may also be able to carry that loss backward to the prior two years, reducing the income and taxes for those years. This is a valuable option if your tax rate was higher in earlier times or if you could benefit from access to a refund right now.
Whatever NOL you don't need to use in prior years can be then carried forward to future years — up to 20 years. A large loss, then, can help your bottom line and lower taxes for decades.
An operating loss isn't always fun to see, but it's not always something to panic over. By looking at it from an objective viewpoint, you may even find that it actually aids your company become steady and profitable in the long run.