Tax & Business Newsletter: November 2021

Losing money is never fun, but business losses can potentially be deductible. Here’s what you need to know. Also consider these tips for maximizing your business’s customer retention.

In this issue:

New Rules Could Limit Your Business Losses

Here’s what you need to know about net operating losses starting in 2021

It’s never fun to lose money, but business losses are tax-deductible. Unfortunately, the rules for deducting losses have undergone multiple changes over the past few years, and more changes could be coming. Here’s where things stand now.

Background

If a business’s deductions exceed its income, it has a net operating loss (NOL) for the year.

Example: Brandon earned $80,000 in income from his sole proprietorship business. He had $100,000 in expenses and no other income. His NOL is $20,000.

You’ll owe no income tax the year you have an NOL. But you can also use an NOL to reduce taxes in other years when your business does turn a profit.

NOLs for 2018 through 2020

NOLs incurred during 2018 through 2020 can be carried back five years. That is, you can apply an NOL to prior tax years by filing an application for a refund or amending a prior year tax return. This enables you to get a quick refund from the IRS for all or part of the taxes paid in previous years. Any remaining NOL is then carried forward indefinitely until used up. NOLs for these years may offset 100% of taxable income to reduce your tax liability to zero.

Example: Assume that Brandon incurred his $20,000 NOL in 2020. He may carry it back to 2015 to reduce his taxable income for that year and obtain a refund of up to 100% of the tax he paid. If he has any NOL amount remaining, it is applied to his 2016 through 2019 tax years in turn. Any remaining NOL is then applied to 2021 and any number of future years. Alternatively, Brandon could elect to only carry his NOL forward to 2021 and future years.

NOLs for 2021 and Later

Starting with the 2021 tax year, the NOL rules are much more restrictive:

  • You may only deduct NOLs for the current year and any number of future years. You may not carry them back to deduct in prior years and get a refund.
  • NOLs for these years may only offset up to 80% of taxable income for any year.
  • For 2021 through 2026, NOLs are subject to an annual limit of $262,000 for individual taxpayers and $524,000 for married taxpayers filing jointly. Losses over these amounts must be carried forward.

Example: Assume that Brandon incurred his $20,000 NOL in 2021. He may not carry it back to reduce his taxes for any past years. He may only apply the NOL to 2022 and later, offsetting up to 80% of his taxable income for that year.

Strategies to Deal with New NOL Rules

Since you can’t carry NOLs back, consider creating more taxable income for the NOL year so you can make immediate use of your loss:

  • Convert your traditional IRA to a Roth IRA if your business is a flow-through entity. The conversion amount is taxable income you can offset against your NOL on your personal tax return.
  • Take a taxable distribution from your traditional IRA (but only if you don’t have to pay any penalties).

Example: Brandon converts $20,000 from his traditional IRA into a Roth IRA. The $20,000 offsets his $20,000 2021 NOL because these business losses flow to his personal tax return, resulting in zero net taxable income for the year.

Please call if you have any questions about an NOL for your business.

Ideas to Improve Customer Retention

Retaining your current customers is a great way to ensure your business remains profitable. Here are some suggestions for maximizing customer retention:

  • Track and analyze retention metrics. There is an old saying attributed to Peter Drucker, “What gets measured, gets managed.” So measuring your active customers this year versus last year will not only tell you who you retain, it will also tell you who you lose! Track your retention rate as a percent of last year, then compare the number over time to see if it improves or worsens.
  • Obtain customer feedback. If you can identify customers no longer ordering, talk to them. Find out why they no longer use your products or services. Then try to reactivate them. It may not work, but the information they provide can be very powerful to help retain your current customers. If customers are not readily identifiable, consider creating a process to collect customer feedback on a regular basis, then share that information with your employees.
  • Be proactive with customer communication. Understand your customers’ normal buying pattern and then organize your communication around this pattern. An extended period of no communication can easily lead to customers wandering into other alternatives. So consider a contact plan to re-establish your customer relationship. If you have multiple products and services that a customer may be interested in, consider these calls as an opportunity to up-sell and cross-sell. But find the balance, as too much communication can also turn off your customer base. Look for opportunities that your customers will welcome.
  • Send a newsletter. Newsletters are a great and easy way to stay in touch. Mix in topics related to the problems your products and services solve. Even better, consider mixing in topics that are generally helpful or that show your firm’s culture. So if your group was out helping the elderly clean up their yards, or donating products to those who need them…let everyone know. Or perhaps an article relating to protecting yourself from hackers, or talking about hot trends. The key is to get your customers to engage and connect your name with something useful and interesting. The simple act of a newsletter arriving in an inbox keeps your company top of mind.
  • Differentiate your product or service. Try to understand why your most loyal customers come back to you over and over again. Understand what it is and then try to put this information in your marketing and retention plans. These reasons can be a meaningful point of difference for your company. A differentiated service offering that solves your customer’s unique pain points will always help you retain customers in the long run.