Planning for Losses: Past, Present and Future

No one plans to incur a loss. Many smart marina and boatyard professionals do, however, “plan” to minimize the effect of losses, reverse them more quickly and, in some cases, reap the benefits of increased cash flow and lower tax bills today and in the future.

Whether the result of the economy, competition or events outside the control of the marina and boatyard professional, losses are almost inevitable. Thanks to our tax laws however, planning for losses, whether past losses, current losses or anticipated losses, can help every boatyard and marina -– and its owner/shareholder/partner -– ease the bite of those losses, recover faster and, in many cases, reap several tax breaks.

Ensuring preferential tax treatment -– and a lower tax bill -– for losses should begin now, well before any loss occurs. Consider, for example, the routine losses every business may encounter.

Casualties and Other Losses
Casualty losses, at least if they are the result of a legitimately declared “disaster,” can be utilized to recoup taxes paid in the previous tax year. In essence, a casualty loss resulting from a declared disaster may be claimed as a tax deduction in the year preceding the year in which the disaster actually occurred. This allows the marina or boatyard to amend its prior year tax returns and receive an immediate refund as a measure of relief.

Inventory losses, casualty and theft losses (to the extent not covered by insurance) and losses on the sale of business assets may also be deductible. Losses occurring from fire, storm, shipwreck or other catastrophic events are clearly tax-deductible. Of course, casualty losses must be due to a sudden, unexpected or unusual event to qualify as a tax deduction.

It’s no secret that the owners and operators of many troubled businesses have discovered the advantages of big-time losses.

Operating losses
While lost profit is not actually a loss, an unpaid invoice might be. In fact, it may be possible to write unpaid invoices off on the annual tax return. Unfortunately, these losses are available only to those marinas and boatyards using the accrual method of accounting. This means that the total for those invoices was already included in the operation’s gross income reported to the IRS.

Business bad debts, on the other hand, are often labeled as losses. Regardless of whether the business’s bad debt arose from an owner’s loans to his or her business or from loans to others, so long as they are business-related, they can be deducted to the extent of their worthlessness.

Unfortunately, business bad debt deductions are not available to shareholders who have advanced money to a corporation as a contribution to capital or to creditors who hold a debt that is confirmed by a bond, note or other evidence of indebtedness.

There are also those losses that can be controlled. Quite simply, a loss is allowed for the abandonment of an asset. If a depreciable business asset or an income-producing asset loses its usefulness and is subsequently abandoned, the loss is equal to its adjusted basis. Obviously, an abandonment loss must be distinguished from anticipated obsolescence.

Net Operating Losses
Depending on how much of a loss it sustains, the business can benefit from the negative income for a prolonged period of time until it becomes profitable again.

A net operating loss, or NOL, is the total excess of allowable deductions over gross income, with required adjustments. In other words, if all the operation’s expense deductions exceed income shown on the tax return -– or the owner’s return -– there may be a NOL.

Owners of an unincorporated business — a sole proprietorship, partnership or limited liability company — can claim their business operating losses on their annual individual tax returns. A NOL simply means a business’s deductions are more than its income.

Currently, NOLs can no longer be carried back to offset the taxable profits in earlier years. They can, however, facilitate future tax relief.
NOLs can now be carried forward indefinitely, although they are limited to a maximum of 80% of the upcoming year’s income. A 20-year limit applies for losses that occurred prior to 2018.

Too Much Loss
A number of unfortunate business owners, particularly those whose businesses operate as a pass-through entity, have discovered that there can be such a thing as too much loss. The Tax Cuts and Jobs Act continues to restrict the amount of losses a sole proprietor, partners, S corporation shareholders and limited liability members can currently deduct.

If a pass-through business generates a tax loss this year (2024) or next (2025), it cannot deduct an “excess business loss.” An excess business loss is the excess of the marina or boatyard’s total deductions for the tax year over the sum of:

The aggregate business income and gains for the tax year, and $250,000 ($500,000 for taxpayers filing jointly)

The excess business loss is carried over to the following tax year where it is deducted under the NOL rules.

For those business losses passed through to individuals from S corporations, a pass-through partnership or an LLC that is treated as a partnership for tax purposes, the excess business loss limit applies at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on his or her personal federal income tax return.

It should be kept in mind that the excessive business loss limits apply after applying the Passive Activity Loss (PAL) rules. The PAL rules prohibit taxpayers from using passive losses to offset earned or ordinary income.

Losses from Passive Activities
Investors need to be aware that the tax rules are pretty clear regarding ordinary losses, which can only be deducted against ordinary gains, while capital losses can only be deducted against capital gains. Since most people usually have much more ordinary income than capital gains, ordinary losses are usually more useful than capital losses in reducing taxable income.

Passive activities are those in which the owner or shareholder doesn’t materially participate. Material participation is generally defined as being involved in an activity on a regular, continous and substantial basis.

Under these rules, passive activity losses that exceed income from passive activities are disallowed for the tax year, although they can be carried forward to the next tax year where they face the same passive loss restrictions.

More Losses
Among the seemingly never-ending list of losses are those resulting from insolvent banks and other financial institutions. Yes, the FDIC insures deposits up to $250,000 per depositor, but only deposits in FDIC-insured banks. It does not cover non-deposit investment products or default or bankruptcy of any non-FDIC-insured institution.

Planning Essentials
Planning for losses begins with the key types of losses recognized by the IRS. The tax rules allow deductions for ordinary losses from ordinary income. This reduces the amount of taxable income and reduces the income tax bill.

Capital gain, on the other hand, is the profit received when property is sold other than in the ordinary course of business. Capital losses arise when that kind of property is sold at a loss. The sale of publicly traded stock (such as shares of IBM) by someone other than a stock trader is an example of capital gains and losses. Deducting capital losses against capital gains reduces the amount of taxable income, thus reducing the amount of income taxes.

Owners of unincorporated businesses who sell or liquidate their businesses at a loss are allowed to deduct those losses against their ordinary income.

Owners of corporations who sell or liquidate their corporations at a loss are required to deduct those losses against their capital gains.

If capital losses exceed the owner’s capital gains, they are allowed to divide the loss into increments of up to $3,000 per year and deduct that amount against their ordinary income. At that rate, depending on the amount of the capital loss, it may be many years before the entire loss is deducted.

Loss Rewards
Tough times mean making the most of a bad situation by utilizing our existing tax laws to reap profits from every loss. Whether as a result of economic conditions, competition or factors outside the control of the marina and boatyard professional, every business is at risk of losses. Planning for losses can help every business reap favorable income tax deductions, which may in turn ease the risk of failure.

Would a refund on taxes paid by the formerly profitable boatyard or marina in years past help ease the pain of lingering losses this year? What if last year’s business losses could offset next year’s profits and reduce the tax bill for years to come? All this, and more, is possible with “loss” planning.

Under our present tax rules, any loss sustained during the taxable year, or a loss not covered or “made good” by insurance can be claimed as a tax deduction. Naturally, professional assistance is suggested, as is monitoring the inevitable changes to our tax rules.

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