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Q: I am a sole proprietor. My question concerns how I can make use of a tax loss from 1998 to decrease my 2000 tax-year tax. Because of a project for which I did not get paid (due to the default of the company for which the work was done), I have a $236,000 residual tax-loss "carry forward" (line 8 on Form 1045 from 1998). What procedure is involved in using this carry forward against my current 1040 taxable income for the 2000 tax year? There is no understandable information concerning how it should be handled in any of the IRS tax information that I have been able to obtain.
Do I first complete my 2000 tax year 1040 and determine the amount of tax due, then recalculate the
tax for the 2000 tax year using Form 1045, pages 1, 2, 3, and 4? Do I submit both the current 2000 tax year Schedule 1040 and the current 1045 showing the computation for the current tax year decrease? I have asked the IRS, but to date have not received any definitive answers. No one at the IRS office, when contacted at their 800 829-1040 phone number, appears to have any understanding of what I should do. I get passed from one alleged tax expert to another, but never find one who can actually answer the question. If the IRS doesn't know how to handle this, how is anyone else supposed to know?
A: Before we discuss how to handle net operating losses, we have to decide if your business is on the "cash basis" or "accrual basis," which would have been determined on your business's first tax return.
Cash basis: Most sole proprietors are on the cash basis, which means that you recognize income when you receive the cash and expenses when you pay them.
Accrual basis: This means that you recognize income when you have the right to receive it and expenses when they are incurred and a cost is determined. Some accrual-basis businesses incur business bad debt, which occurs when outstanding receivables become uncorrectable.
Let's assume your business is on the accrual basis and has a $236,000 net operating loss from 1998. You may carry this loss back to the 1996 and 1997 tax years and then forward to the 1999, 2000, and future tax years up to 20 years. You can also elect to forego the carry-back period and only carry the loss forward. The election to carry forward had to be made on your 1998 return.
If you chose to carry the loss back to previous years, you can use Form 1045. If you are carrying the loss forward to future tax years, you may take any unutilized loss from 1999 up to the amount of profit on your Schedule C or other business income. You can report this loss on page 1, line 21 of the (2000) federal return as an offset against your business income. You must still pay self-employment taxes on the money earned from the business, but the net operating loss carry-forward will eliminate some income tax associated with business profits.
If yours is a cash-basis business, there may be no loss to carry forward or carry back. The $236,000 in unpaid revenues would not have been recognized on your 1998 return because no cash was received. Only the expenses associated with this project may have created a net operating loss in 1998. If this is the case, you can use the net operating loss on your 2000 return the same as described above.
When dealing with complex tax issues or large amounts of money, it's wise to consult a professional because the smallest mistake could make a big difference on your tax bill.
Kevin Boeving, CPA
Poppen & Associates, CPA's, P.C.
St. Louis, Mo.
Editor's note: While the information in Tax Adviser represents the opinion of an expert, it is not legally binding. Do you have a small-business tax question? Tax professionals will answer your questions in the Tax Adviser column, appearing here Wednesdays. E-mail Taxadviser@businessweek.com. We will not print your name, address or phone number, but please provide this information.