What You Should Know about Filing Taxes with Business Losses
Here at The Accounting Guys, we specialize in working with business owners. We know the ins and outs of working with businesses’ books and filing their taxes—and we know that facing a year in the red is far from an uncommon occurrence for businesses. But how do you file your taxes when your business has a loss for the year? Here’s some important information you’ll need to know. For further assistance, reach out to our Provo business tax experts to schedule a consultation.
Understanding Net Operating Loss (NOL) Rules
When a business incurs a net loss for the year, it’s possible you could qualify for a net operating loss, or NOL. This can be applied to reduce taxable income in future profitable years. A NOL can be a powerful tool to improve your long-term business finances, but it’s important to understand the rules surrounding this potential tax break.
A NOL occurs when a business’s total deductions exceed its total income during the tax year. This loss can be “rolled over” to offset your future taxable income, helping to lower tax liabilities when you start turning a profit again. NOLs can offset up to 80% of taxable income in future years. This means that, even if your NOL amount is significant, you can’t entirely erase your taxable income if you turn a profit in the future. However, you can reduce it significantly.
Properly Deducting Losses on Your Tax Return
The way your business’s losses are handled on your tax return will vary depending on your company’s business structure. For sole proprietorships, partnerships, and S corporations, the losses pass through to personal tax returns, potentially reducing your personal income tax too.
· Sole Proprietorships: This business structure reports income and losses on a Schedule C (Schedule F for farming businesses) of Form 1040. If you have a net loss, it can reduce your total taxable income on your personal return.
· Partnerships and S Corporations: These business entities pass losses on to their partners or shareholders, who in turn report them on their personal returns. This can decrease the individual’s taxable income, but the IRS does limit how much loss can be claimed based on at-risk and passive activity rules—more on that below.
· Corporations: C corps are separate tax paying entities from their owners, and the business itself files its own tax return. Losses are reported on Form 1120, and impact the corporation’s taxable income. These losses do not impact the personal income taxes but can provide carry forwards for corporate tax savings in your more profitable years.
Understanding At-Risk and Passive Activity Rules
When claiming a net loss on your tax return, you need to ensure you’re complying with IRS rules related to risk levels and activity types. These restrictions limit how much loss you can use to reduce taxable income.
The at-risk rule requires your investment in the business to be genuinely “at risk.” This means you could actually lose it if the business fails. If your investment is protected from personal loss, the deductibility
of your losses may be limited. For business owners not actively involved in daily operations, losses may be considered “passive,” which means they’re only deductible to the extent of your passive income from other sources. On the other hand, if you’re actively participating in your business, such as having a hand in management decisions, you can avoid these restrictions and maximize your deductible losses.
Get Help from a Tax Professional
Filing a tax return when your business has a net loss, filing a tax return properly can get a lot messier. A tax professional can help ensure you’re taking full advantage of any tax benefits available while remaining compliant with the IRS’s rules. Contact The Accounting Guys today to speak with one of our experienced Provo business tax experts.