This post was inspired by the stories of some of my neighbors and clients in southern New Jersey. Most were struggling with a weak economy before super storm Sandy hit in late 2012. Those that re-opened over the next few years face continued business losses and the prospect of continued weakening of the local economy for the next decade.
What to do when your business is losing money? Fix the business model or close shop are the obvious answers. But those are not always doable. A family farm, for example, is likely to keep running at a loss for years or decades after it is no longer profitable. There is often no desire to sell the homestead farm and making current income is often not the primary economic driver of the business. Other businesses like marinas or fish processing may expect economic cycles to last much longer than a decade. Predicting the future is part of financial planning, yet it is far from a reliable practice. Business plans must be flexible to accommodate a wide range of unanticipated business outcomes.
The list below, in no particular order, is not meant as an exhaustive discussion but rather just a listing of some issues to consider in financial planning:
1. IRS Hobby Loss rules – Section 183 of the federal income tax code require that businesses be engaged for profit in order to make any losses tax-deductible against other income. Tax planning is required in order to achieve best overall financial results.
2. Safe Harbor rule – the IRS relies on a “safe harbor” rule upon which a business owner can rely. Lean on this for financial planning whenever possible since it is the clearest, cheapest and least risky financial strategy.
3. Conservation easements – limiting rights to future land use saves money now
4. Sale/ Lease back – perhaps the business should not own the land/buildings that it uses.
5. Grants – government grants to save a business or industry are taxable so plan accordingly
6. Tax shelters – matching high income individuals with otherwise attractive money-losing businesses is the oldest tool in the tax shelter business. Just be sure to do it properly to avoid IRS scrutiny.
7. Professional representation – If IRS does start ask questions, it may be costly to a business. This is not a “do-it-yourself” area of tax practice. An experienced attorney, CPA or Enrolled Agent are required if you reasonable expect to prevail in an audit.
8. Conversion to nonprofit status – this is applicable to businesses, for example, that may be a historic landmark of bygone days but are no longer profitable today. The community may be willing to pay to keep the doors open.
9. Investor basis – businesses with changing ownership (corporations or some LLCs) need to pay attention to the tax implications of transactions that affect the calculation of the business owner’s “basis”. Basis is a concept that is important in tax law, especially when calculating long-term business losses and taxable gains on sale of a property.
10. Risk Management – the reality is that distressed businesses are more likely to suffer calamities. Be aware and plan accordingly.
11. Insulation – make sure that the struggling business does not pull down other unrelated businesses, your personal finances (what’s left of them) or your personal relationships. This is far easier said than done. Professional help may be wise.
12. Buyouts – state governments increasingly recognize that the dramatic physical and economic impact of climate change will make some areas uninhabitable. Nobody likes to talk about it, but property buyouts and/or relocations are happening now and will increase in the future.
13. Debt relief – a distressed business that borrows money through difficult times will have substantial taxable income (but no cash with which to pay applicable taxes) if that debt is later discharged. But the rules vary so be sure to consider the details far in advance of discharge.
A business owner struggling with long-term losses is not likely in the best mental state to make an objective analysis of all of the options. I strongly suggest getting outside professional advice from an adviser who sees the “big picture”.