Sell Losses at Your Failed Company for Cash. Take Full Advantage of Tax Credits. You worked hard to build your business. Realize all the fruits of your labor when it comes time to file your return.
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Everyone invariably fails in life somewhere along the way. But very few events will cause as much emotional and financial pain as failing at startup or business.
My most recent startup, Autotax.me, failed and I lost about $80,000. But I was able to use those losses to generate $11,619 in cash. Every entrepreneur needs to know that the time, money and heart put over the years always has tangible value -- whether successful or otherwise.
Failure is common. Just look at the statistics from the U.S. Bureau of Labor. Most of my entrepreneurial successes are a direct result from the failures I've accrued over the years. And I fully intend to fail again in the future.
Related: Selling Your Business at Your Price
Taking net operating losses.
Net operating losses are created when a company fails to bring in more income than expenses. These net operating losses can be used be used to lower the entrepreneur's personal income tax or the company's corporate tax by applying the losses to their present, future or past tax years. Net operating losses used in the present and future tax years will lower your taxes due. Losses used in past tax years will help you obtain a tax refund. Using net operating losses to help stem a company's leaking cash is par for the course for any legitimate business.
Consider, for example, the situation of Bob, who owns an limited liability company that lost $100,000 this year. Bob can take those losses on his personal income tax return for the previous year and obtain a refund. Assuming Bob made $100,000 last year, then his tax refund would be $31,767 based on 2013 tax rates. If Bob knows that he's going to make even more money in the future, then Bob can instead apply the loss to a future tax year to save even more.
What if Bob didn't earn $100,000 and doesn't expect to earn that much in the near future. He can still sell his losses to another company or individual in need of that deduction to lower the taxes due. Bob can sell his losses because he could sell an interest in his limited liability company.
Selling net operating losses is achieved by selling an interest or percentage of the company. The Internal Revenue Code under Section 704(a) allows partners to allocate or share their profits and losses at their discretion. But, partner allocations are limited under certain rules such as Section 704(d). This rule explains that losses may only be deducted against the amount of "adjusted basis" or equity a partner has in the company. This rule can be circumvented by a relying on an debt restoration obligation to increase the amount of "adjusted basis" in a company.
Other tax rules govern corporations but entrepreneurs are still allowed to transfer their losses by selling a share of the business. The United States tax code is a behemoth that has created secondary markets similar to Second Life. Imaginary numbers are traded to obtain real-life cash.
Selling tax credits.
Startups and businesses have more than 250 types of tax credits that they can take advantage of at the federal, state and local governmental levels. Tax credits can be obtained, for example, for restoring property, making films, hiring people or just developing something new. Yet, companies rarely take advantage of these programs. Many business owners don't even know what tax credits are available.
Plus business owners might not have the income in the early years to hire accountants to help. These tax credits were meant to help new companies grow and succeed, but many entrepreneurs aren't able to take advantage of them. Indeed larger and established businesses are the ones that are most able to take advantage of these tax credits.
Baltimore-based Chesapeake Community Advisors founder Dave Prout explained to me how he has helped businesses sell their tax credits to help fund low-income housing, a hotel and other enterprises. Prout connects tax-credit buyers and sellers to ensure that everyone is fairly compensated. In some cases tax credits can be sold directly to secondary parties without selling an interest or equity in the company.
An entrepreneur's best option might be to claim the tax credits and sell them to a larger company. There are hundreds of secondary markets available to help small companies generate immediate cash. Smaller tax-credit sellers can use websites such as Baxi Exchange, Online Incentives Exchange and Tax Credit Exchange.
Or an entrepreneur could try selling the company as a shelf company but lately this type of business has obtained a rather unsavory reputation. The time and effort spent building a company was not wasted but has a real value that is immediately marketable. Stumbling blocks along the way are common and a means along the way toward building a future success.