Dear Tax Talk,
Continue Reading Below
I am a sub S small-business owner with tax losses that ought to cover my income for 2011. I have a $100,000 SEP IRA (simplified employee pension IRA), to which I no longer contribute. I think I should convert it to a Roth IRA because I am assuming that my 2011 losses will cover the tax ramifications. Is there any flaw to this thinking, and do I have to convert the SEP to a traditional prior to conversion? What's the best tax write-off for small business?
While business losses are never a positive benefit, appropriate planning for the utilization of the loss is important. When you sustain a business loss, it means you have spent more money than you started with. In order to have spent that excess, it had to come from somewhere. In order to continue in business, you're going to have to replenish that source. How you replenish that source will have tax implications.
To create the loss, you had to have spent the money from previously accumulated earnings, borrowed funds and/or original capital.
Each one of these is a scarce resource in an ongoing business venture. In order to restore these amounts in the future, the company will have to generate taxable income. If you utilize the current loss to offset a Roth IRA conversion, you'll have to work doubly hard to pay the taxes on these future profits. This may be the flaw in your thinking.
Rather than use the loss for the conversion, you can elect to carry forward a business loss to future tax years. By electing to carry forward the loss, you can mitigate the future tax impact of profits. Alternatively, if you need some capital, you can carry back your loss to prior year's taxes and get a tax refund. A $100,000 loss carried back to a prior tax year may generate up to a $35,000 refund if you were in high tax brackets previously.
Before you worry about the SEP IRA, I would worry about the future needs of the business.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.