Based on Your Business’s Structure
The way your net loss is handled on your taxes is impacted by many factors, the first of them being your company’s legal structure. For the majority of business types, profits—and the losses—are passed on to the owners or partners in one way or another. For example, in a sole proprietorship, the owner absorbs all the risk and investment required for the business, and often receives the business’s profits as income. In pass-through entities (like S-corps), profits and losses are passed on to the partners.
So, in most of these instances, the business’s net loss would be deductible on the owners’ or partners’ personal tax returns, just as the business’s net profits would have been reported on their returns in years that the company turned a profit.
However, there are some types of business structures (such as C-corps) that exist as a separate entity from the owners. This means that the company has its own funding, its own accounts, and its own taxes. In these cases, the owners would not be able to deduct a business loss on their own returns.
Other Limitations
While the above explanations may make it seem rather simple, deducting a business’s losses is actually far more complicated than knowing your company’s structure. There are several other limitations that must be taken into consideration that will impact not only your ability to deduct the losses, but just how much of those losses you can deduct. These include:
Passive activity rules – Your level of activity in the business may impact your ability to deduct the company’s losses on your return. If you’re not engaged in the business on a regular or substantial basis, you can only use the business’s losses to zero out your income from the company. Basically, if you’re not actively working to ensure the business turns a profit, you cannot use its losses to reduce your personal income.
At-risk rules – In certain types of businesses, the partners or owners may not have equal risk in the company. For these situations, your ability to deduct the company’s losses on your return may be impacted by how much you have “at risk” in the business. This most often applies to companies like S-corps, partnerships, and multiple-member LLCs.
Excess loss limits – Finally, if your business had an extremely large loss this year, you may be limited on just how much of that loss you can write off. The Tax Cuts and Jobs Act of 2017 capped the business losses you can write off at $250,000 for individual filers, or $500,000 for couples filing jointly. If your company’s losses exceed those limits, you can only write off the maximum amount specified above; additional losses would simply have to be absorbed.
Because of the many limitations and various factors impacting your ability to deduct your company’s losses, it’s extremely important that you allow a professional with knowledge and experience in these matters to handle your tax return if you’re a business owner.
How to Deduct a Loss
After considering all of the above factors and how they impact your unique situation, you may still be able to deduct your business’s losses. If your company is a sole proprietorship or single-member LLC, you can deduct the loss on Schedule C, which is added to your personal tax return. Those with an active stake in a partnership or multiple-member LLC will calculate their business taxes on a partnership tax return, with losses passing through to individual partners’ returns. For S-corps, business taxes are calculated on Form 1120S, once again with losses passing through to owners. However, if your company is a C corporation, losses are not passed through and, therefore, cannot be deducted.
If you have questions about deducting your business’s net operating loss, please contact us to speak to a business tax expert in Provo.