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Regardless of where your income comes from, you know that you have to pay taxes on it. If you’re an owner or partner in a business, you are expected to pay taxes on your portion of the business’s profits (whether it’s the entirety of a sole proprietorship’s profits, or a percentage of a partnership’s profits). But what happens when that business operates at a loss? Can you report that loss on your taxes? And if so, how does that impact your tax return? Keep reading to learn more about claiming a business loss on your taxes.

You Can Usually Deduct a Loss

First, the short answer to the question of whether or not you can deduct the loss is “yes.” In the most general terms, you can typically deduct your share of the business’s operating loss on your tax return. However, the long answer to this question is much more complicated.

There are many limitations on deducting these losses, and much of it is based on your business’s legal structure (partnership, sole proprietorship, corporation, etc.). Your level of investment in the business and the associated risk to you is also considered, and any other household income you may have (from another job, your spouse’s income, etc.) can also be factored in.

So, though the short answer may make this sound quite simple, the longer truth of it is that deducting a business loss is extremely complicated. If you’re hoping to make this type of deduction this year, please reach out to us and work with one of our experienced CPAs to ensure it’s done right.

Limitations on Business Loss Deductions

As mentioned above, there are many limitations to whether or not you can deduct a business loss on your personal return, and further limitations on just how much you can claim. Here’s a quick look at some of those limitations:

• Excess loss limits – More often than not, a business loss can be used to reduce an individual’s taxable income. However, the Tax Cuts and Jobs Act of 2017 placed limits on just how much you can deduct on your personal return. You can only deduct up to $250,000 of business losses on your personal return (or $500,000 if filing jointly). If your business losses exceed these limits, you can only deduct the portion specified above; any remaining losses would simply have to be absorbed.
• At-risk rules – For certain types of businesses (namely, S corporations and partnerships), the amount you can deduct is based on how much you have “at risk” in the business. In many of these businesses, some partners absorb more of the risk than others, and so would be able to take a higher deduction if the business operates at a loss. This doesn’t typically apply to sole proprietorships or single-member LLCs, as you are the only owner/partner, and therefore absorb all the risk yourself.
• Passive activity – Your ability to deduct a business loss may also be impacted by your level of involvement in the business. If you do not engage on the business on a regular or substantial basis, you cannot deduct business losses on your personal return; instead, you can only use the business’s losses to reduce your income from the business to zero. Essentially, if you’re not actively engaging in the business in order to ensure it turns a profit, you cannot use the losses to reduce your personal tax liability.

Carrying Over Business Losses

While you can usually deduct business losses on your personal return, there is another option for how to handle business losses—carrying the loss forward to future tax years. This option allows you to count the current year’s operating loss as an “expense” of sorts on the next year’s taxes. The amount that can be carried forward is limited to 80% of taxable income. However, there isn’t a limit on how many years you can apply this option to.

Please note that, in the past, businesses could carry a loss back to past tax years; this option was eliminated in 2017 by the Tax Cuts and Jobs Act. You should also be aware that the carry-forward provision is not available to corporations.

Deducting Your Business Loss

Taking all of the above factors into consideration, you may be able to deduct this year’s operating loss on your personal return, thereby reducing your taxable income. For a sole proprietorship or single-member LLC, you can do this on Schedule C, alongside your personal tax return. Partners and owners in multiple-member LLCs can do the same, deducting their percentage of the business’s loss. However, owners in a C corporation cannot deduct business losses on personal returns.

If your business has been operating in the red this year, contact us to learn more about how you can deduct your business’s losses on your personal return.