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R. Klein, EA
R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 3375
Experience:  Over 20 Years experience
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I quit my full time job three years ago to start a business.

Customer Question

I quit my full time job three years ago to start a business. Since then I have had no income, but using my own savings and money borrowed from family and friends to pay for both the living expenses and business expenses. For the past three years I have had net operating losses for business expenses, which are reported in form 1040 schedule C, and I elected to carry the NOL forward. But I noticed that my tax software (Turbo Tax Deluxe version) only reports the current year's NOL, ignoring the previous years’ NOL.

My question is, can I file it as is (I requested for extension, and must now file by Oct. 15), assuming eventually I can offset my future income (possibly, next year) with all the NOL accumulated throughout the past years, or should I manually change the number in this year’s 1040 to reflect the accumulated losses? If I need to change, how do I indicate that I have accumulated NOL?
Submitted: 3 years ago.
Category: Tax
Expert:  R. Klein, EA replied 3 years ago.

R. Klein, EA :

Thank you for contacting me about your Tax issue. I will work hard to help you understand the issue clearly.

R. Klein, EA :

When you say you have an NOL, my first question is, do you have a Net Operating Loss, or a loss in your business? There's a BIG difference for a sole proprietor.

R. Klein, EA :

A few questions: What type of business do you have? How big was the loss on Schedule C in 2011? 2012?

JACUSTOMER-8fb54q8i- :

OK I don't know the difference between NOL and loss in business. Here is some more info.

JACUSTOMER-8fb54q8i- :

I develop algorithms and software for data processing based on my research. This is pretty typical of a startup company in our area, except that I have not received outside venture capital investment yet, and have not generated revenue yet., but getting close. The loss was in the 30 to 50 k range for the past three years or so, (I don't have the exact number with me now.) The expenses are mainly in hiring oversea engineers and travel, and hiring legal professionals in filing patents.

R. Klein, EA :

SO each year you spent more than 30K more than income you earned.

R. Klein, EA :

Did you have ANY sales yet or is everything you are doing "getting ready" for sales?

JACUSTOMER-8fb54q8i- :

I actually don't have income, I borrow money from private sources plus using my own savings. Yes, each year the loss is in 30 - 50 k range.

R. Klein, EA :

So you have no customers and you are just setting up with all this work and expenses you have now?

R. Klein, EA :

I would say that it would be not just an idea, but a VERY good idea that you consult a tax expert sooner rather than later.

R. Klein, EA :

I see a definite problem if these expenses generate losses or NOLs because it is incorrect accounting based on what I have heard so far.

R. Klein, EA :

Most of these "expenses" need to be capitalized, not expensed. It means losses will be disallowed in the past, but you will have future deductions once you start sales.

R. Klein, EA :

There are complex accounting rules with intangible assets, such as algorithms.

JACUSTOMER-8fb54q8i- :

eventual, the algorithms will be a software product, or patent rights.

R. Klein, EA :

Yes, patents are amortized over 15 years to be exact.

JACUSTOMER-8fb54q8i- :

So, I should ask a tax expert to redo all my taxes for that past years.?

R. Klein, EA :

I would recommend filing a return, even if it has no amounts on Schedule C. It will be easier to amend it once it is filed on-time.

R. Klein, EA :

Oh definitely.

R. Klein, EA :

It sounds like you have a major error on your hands. One that has an impact bot going backward AND forward.

R. Klein, EA :

I don't think you have any NOLs

JACUSTOMER-8fb54q8i- :

I do plan to file by Oct. 15 using the numbers produced by my tax software as is. If so, can I hire an tax expert to redo it, say next year, as I expect to have some income from this business next year.

R. Klein, EA :

You may do that.

R. Klein, EA :

But your tax software is following the rule of GIGO

JACUSTOMER-8fb54q8i- :

I wish I could have more detailed instructions on how to correct the problem, so I can know what to talk to the tax expert later. Sorry for asking a question for a complicated problem. I did not rate the answer as OK but I do not mean the service is "poor" as the button indicates. Hope you don't mind.

R. Klein, EA :

I'm sorry that we have not met your expectations yesterday.

R. Klein, EA :

The How to Correct the problem question requires you to have a substantial base of knowledge of accounting rules. In terms that you might relate to, it would be like you trying to explain a component of your algorithm to me via this chat using only lay terms.

R. Klein, EA :

It is not possible for me to explain all the components and discuss all of the choices when determining how much of your development must be considered a capital asset without actually seeing all your entries in your books.

R. Klein, EA :

The big picture you need to know is that you don't have this large Net Operating Loss because of the proper accounting treatment needed for the type of expenses and business you have. This is something that you should visit with an accountant or tax advisor in person to discuss because there are many ramifications.

R. Klein, EA :

Large NOLS for many years without any source of income are indeed a red flag to the IRS computers. These types of entries ARE picked for examination, In addition, while you may think it is OK to have negative income, what you are really doing is setting yourself up for higher taxes in the future because you won't have the deductions when your income is higher.

R. Klein, EA :

This is NOT a do-it-yourself accounting project. TurboTax will only process the information you put into it. If you don't put in the data correctly, TurboTax will not spit out the BEST answer. It will give you AN answer. In this case, it's not just put this number in Box Z. You MUST know the accounting rules BEFORE you put numbers in boxes Z, Y and X.

R. Klein, EA :

So the BEST answer I can give you is: Consult a Professional in person. The professional needs to see your books and discuss many questions with you. There AREchoices to be made and everything is NOT black & white--put it in a box.