Business in the Red? Here's How It Impacts Your Taxes

Author : Camputaro & Associates
Nov 11, 2019

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Taxpayers know that you’re expected to pay taxes on all sources of income. And, if you’re a wage earner, that aren’t too many things you have to consider beyond that fact. However, if you’re self-employed, or you’re an earning partner in a business, there’s another question you have to ask yourself: What happens if the business operates at a loss? How does this impact your taxes? This blog will give you a quick overview of how business losses are handled on tax returns. However, we strongly recommend you work with a qualified CPA to get more detailed advice on handling business losses when filing your return.

Based on Your Business Structure

First, it’s important to be aware that the exact way in which your business loss is handled will be based on the business’s legal structure (corporation, sole proprietorship, partnership, etc.), as well as whether your investment in the business is considered “at risk” in whole or only in part. If you have other income in addition to business income, this is also a factor that will impact how the loss is handled on your taxes.

This is why it is so important to have a CPA go over the details of your unique situation to ensure the business loss is handled properly.

Recent Changes to Tax Law

The Tax Cuts and Jobs Act of 2017 introduced numerous new tax laws, including a couple that impact how business losses are handled. The first is related to carrying over a tax loss to other tax years. In the past, you could carry a loss back to past tax years, but this is no longer an option now. However, you can still carry the business loss forward to future tax years.

The amount you can carry forward is limited to 80% of taxable income, but there is no limit on the number of years you can use the carry-forward option. Carrying forward is not an option for corporations, however.

The other major change to this aspect of tax law relates to excess loss limits. Usually, a loss in a business can be deducted on a taxpayer’s return in order to reduce personal income. While this is still true, there are now limits to just how much you can write off in business losses. A business loss is considered an “excess business loss” if it exceeds the business’s income and gains by more than $250,000 (or $500,000 for joint returns).

The excess loss limits only apply to pass-through businesses, which pass the income on to owners’ or partners’ individual returns. These businesses include sole proprietorships, single-member LLCs, partnerships, and S corporations. The business loss limit does not apply to corporations.

At-Risk Rules and Passive Activity

There are a few additional limitations that apply to claiming a business loss on your tax return. These are at-risk rules and passive activity. Both of these must be applied before you can calculate the excess business loss, as described above.

At-risk rules limit your business losses to the amount at risk in the company. These limits apply to all partners in a business, as well as shareholders in S corporations. For a sole proprietorship or single-member LLC, you’ll need to compute your at-risk situation and report it using Form 6198.

Passive activity can also limit your ability to claim a business loss. These rules apply to businesses in which the owner or owners do not participate on a regular or substantial basis. Losses acquired as a result of passive activity can only be used to zero out the income from that business. Essentially, if you’re not actively working to build the business, you can’t use the business’s losses to reduce any other income you have; you can only deduct enough losses to make your income from the business zero.

How to Claim a Loss on Your Taxes

So, barring the limitations mentioned above, many business owners and self-employed workers can deduct a business loss on their personal tax returns. The way that you do this will depend on what type of business you have:

  • Sole proprietorships and single-member LLCs – This will be done on Schedule C, as part of your personal tax return. The loss is then deducted from any other household income you may have, thereby reducing your overall tax liability for the year.
  • Partnerships and multiple-member LLCs – Calculate business taxes on a partnership tax return. Your percentage of the loss can then be passed on to your personal tax return (just as profits would be passed on to your personal income) and deducted from other income.
  • C corporations – Owners of a C corporation cannot deduct business losses from their personal tax returns. This is because the company is considered a separate entity from its owners, so the business’s funds, liabilities, and tax benefits are separate as well.

If you have any questions about how to handle your business’s net operating loss on your tax return, contact our experienced and knowledgeable tax professionals at Camputaro & Associates.

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Camputaro and Associates
Certified Public Accounting Firm
136 N. Orchard Street, Suite 8
Ormond Beach, FL 32174
(386) 255-2511