“Corporate liquidations are not always profitable, correct?” you ask your wife as you help
put groceries away. She agrees as she hands you the lettuce and paper towels and you continue, “can corporations deduct capital losses in the event of a loss? “Absolutely” she replies, “but there are conditions to consider.”
Can Corporations Deduct Capital Losses?
Corporations can deduct capital losses provided specific requirements are met. Used properly, capital losses can be a powerful tool for lowering a firm’s tax obligation. To properly address Can Corporations Deduct Capital Losses? let’s review the rules and limitations.
Capital Gains Offset – If the firm’s capital losses exceed its capital gains, the excess can be carried back three years or forward five years to offset capital gains in those years.
Short-Term and Long-Term Capital Losses – Capital losses retain their original character of short-term or long-term losses when carried back or forward. The importance is the character of the loss affects how capital gains are offset.
Short-term losses offset short-term capital gains and long-term losses, long-term gains. In accordance with IRS rules, if short and long-term losses and gains simultaneously occur, they are netted against each other.
Filings – Corporate capital gains and losses are filed on IRS Form 1120, U S Corporation Income Tax Return. Capital losses carried back are filed on Form 1139, Corporation Application for Tentative Refund, as a refund request for taxes paid within the previous three years. When carrying capital losses forward, they are recorded on Schedule D of Form 1120 for the applicable year.
Can corporations deduct capital losses and offset capital gains? Absolutely, under IRS guidelines, however, there are disadvantages to consider:
Ordinary Income Limitation – Unlike individuals, companies cannot offset ordinary income with capital losses. Corporations can only use capital losses to offset capital gains. If the company has insufficient capital gains to offset, this can result in a less immediate tax benefit.
Carryforward and Carryback Drawback – The IRS carryforward and carryback provision is favorable tax treatment; however, it also means capital loss benefits are not immediately realized which can negatively impact cash flow and financial planning.
Cost of Compliance – Keeping track of the carrybacks and carryforwards of capital gains and losses can be complicated. Complexity increases the administrative time burden and cost careful record-keeping requires and may warrant the fee-based services of a tax professional.
Opportunity Loss – Tax benefits are time sensitive and if a corporation does not use its carrybacks and carryforwards within a specific period, they will expire. This is a loss opportunity to reduce taxable income.
Opportunity Cost – Opportunity cost is the potential value given up when taking advantage of an alternative opportunity. Using offsetting capital losses may prevent a firm from using those losses in future years when the firm may have more significant gains to offset.
Timing Risk – There is market timing risk in a capital gain offsetting strategy. Capturing tax benefits by selling assets at a loss runs the risk of liquidating a position that may have recovered, increased in value, and potentially resulting in a larger economic loss.
Can corporations deduct capital losses, yet still experience disadvantages, is important for prudent tax planning. Savvy investors not only seek subject-matter education but also professional advice when navigating these tax intricacies.
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