Achieving consistent profits is the goal for any business, but it’s common for companies, especially newer ones, to face periods of no profit. If your business is experiencing such a phase, there’s a tax-related upside to consider. Just as profitable times bring tax benefits, the tax system also has measures to support businesses when they incur losses. This can provide some financial relief and help balance the challenges of a fluctuating business cycle.
This post will discuss the implications of operating a business at a loss. We’ll also address key questions often asked by entrepreneurs, such as “Can I claim this loss on my taxes?” and “How does a business loss affect my taxes?”
Read on to learn more about claiming a business loss on your taxes.
What is a Business Loss?
A business loss is when an organization spends more than it earns within a specific period. This often happens with startups or during the expansion phases of a company when initial investments may yield little profits.
Losses, however, are a normal part of business cycles. In most cases, they reflect short-term financial challenges rather than long-term problems. But business losses aren’t all bad news—you can claim a business loss tax return for the year and recover past taxes paid or reduce future dues for your company.
How Much Loss Can a Business Take?
While the tax code allows you to reduce your taxable income with losses, there are limitations on how to claim a business loss on taxes..
- At-Risk Rules: This rule prevents taxpayers from claiming more than their actual stake in a business. Consequently, only money that you are personally liable for is considered “at risk” and deductible for tax purposes.
Businesses with multiple partners may have varying at-risk amounts, as compared to sole proprietorships or single-member LLCs, in which the owner assumes all the risk. This can affect each partner’s claim deduction if the entity operates at a loss.
- Passive Activity: Your level of involvement in the enterprise also plays a role in determining your ability to deduct losses. If you’re not actively engaged in the business regularly and substantially, the IRS may limit your ability to deduct deficits on your personal return. Instead, you can only use the amount to offset income generated from the corporation. If you’re not actively working to ensure the company turns a profit, you cannot use shortfalls to reduce your personal dues.
How Excess Loss Rules Work
The excess loss rule is triggered when your total company deductions exceed your gross income above a certain threshold. For taxable years beginning in 2024, the limit is $305,000; and $610,000 for joint returns
In simpler terms, if your shortfalls surpass these limits, the excess amount can’t be claimed on your return. Any figure beyond $305,000 (single taxpayer) or $610,000 (joint return) is considered excess and doesn’t contribute to your tax relief. Any remaining sums must be carried forward or absorbed in subsequent years.
Tax Loss Carry Forward Rules
In the case of losses surpassing the provided limit, business owners can still enjoy a tax relief with a “carry forward” provision to future tax years under the 2017 Tax Cuts and Jobs Act (The “carry back” of shortfalls— also previously allowed—is no longer available).
This valuable provision comes with an 80% cap of taxable income and is not available to corporations. However, there is no limit on how many years you can carry forward a loss.
Calculating and Reporting Business Losses
To determine the tax impact of your business shortfall, calculate your net operating loss (NOL). This is how your allowable tax deductions exceed your taxable income.
Add up your company’s annual deficit and other deductions to calculate your NOL. Then, subtract this amount from your adjusted gross income (AGI). You have a net operating loss if your AGI is negative after the deductions.
For example, if your company spent $100,000 on expenses but only brought in $95,000 in revenue, you can deduct $5,000 from your other income. This means if you earn $70,000 from a job, your $5,000 business loss can offset your W-2 income. So, instead of $65,000, you would only be taxed on $70,000.
When reporting your net operating loss (NOL), use IRS Form 1040 Schedule C for sole proprietorships or single-member LLCs. Enter your business income and deductions; the net loss will carry over to your main Form 1040. If you have a partnership or S corporation, your share of the business deficit is reported on Schedule K-1.
Limitations on Capital Losses
Capital gains and losses, such as those from selling machinery or buildings, are separate from operating deficits. There are restrictions on claiming losses on your return for capital transactions.
If your capital shortfalls exceed your gains, you can only claim the excess loss up to $3,000 ($1,500 if you are married and filing separately) or your total net loss on Form 1040 Schedule D.
These limitations protect against unethical practices, such as intentionally running a business at a loss for tax purposes, and preserve the overall integrity of the IRS code.
Deductible Business Expenses
Deductible expenses are the costs associated with running your business that you can subtract from your total income and potentially reduce your taxable amount. Common deductible expenses include office rent, utilities, employee wages, marketing, and business-related travel.
Stay organized, document expenses thoroughly, and explore the various deductible categories to maximize your potential tax benefits. Save receipts and maintain detailed records to ensure you comply with IRS guidelines.
Common Mistakes to Avoid
Navigating the complex terrain of company shortfalls on your tax return requires precision. Avoid these common mistakes to maximize your benefits:
- Inadequate Record-Keeping: Failing to maintain detailed records of business expenses is a cardinal sin. With proper documentation, you can avoid losing out on valuable deductions. Save receipts, track transactions, and organize your financial records diligently.
- Misunderstanding At-Risk Rules: For businesses with multiple partners, misconceptions about at-risk rules can lead to miscalculated deductions. Understand each partner’s at-risk amount to determine the deductible sum accurately.
- Passive Activity Inaction: If you’re not actively involved in your business, the IRS may limit your ability to deduct losses on your personal return. Ensure regular and substantial engagement to claim deficits effectively.
- Exceeding Excess Loss Thresholds: Be mindful of the thresholds ($305,000 for single taxpayers, $610,000 for joint returns). Your dues relief will only contribute to your amount beyond these limits.
- Ignoring Tax Loss Carry-Forward: Remember the potential of carry-forwards. If the amount surpasses the set limits, carry them forward to offset future dues, up to 80% of taxable income.
Also, remember to:
- Double-check calculations.
- Distinguish between personal and business expenses.
- Select the correct form for your business structure.
- Enter all relevant information.
- Pay attention to detail when entering data.
- Attach all necessary supporting documents.
- File your tax return on time.
The Role of a Financial Advisor in Business Tax Planning
Business tax planning can be complicated, especially in the face of shortfalls. A seasoned financial advisor can be a valuable asset in this situation. A skilled advisor, well-versed in financial planning tips for small business owners, can provide strategic insights into optimizing your financial situation and ensure that you make informed decisions in the complex landscape of tax regulations.
Also, the advisor will assess your company structure, analyze financial data, and strategically plan for future tax implications. They can assist with understanding how to report business loss on taxes, the implications of at-risk rules, excess deficit thresholds, and tax loss carry-forwards. This added layer of expertise can help your business minimize liabilities while maximizing potential benefits.
Getting Help With Business Losses
Claiming a loss on taxes for business can reduce your company taxes and improve your overall tax situation. Many entrepreneurs overpay taxes because they need to learn how to claim business losses on tax return.
That’s why at Interactive Wealth Advisors, our seasoned professionals specialize in helping businesses navigate complex IRS tax regulations with expertise. We can help you understand the at-risk rules and strategize tax loss carry-forwards so you can make informed decisions.
You can trust us to provide tailored solutions to help your business weather financial storms and thrive in the ever-changing tax landscape. We also provide Retirement Planning for Business Owners Guide. Contact us to learn how to claim a loss on taxes from business with our Business Owner Financial Planning Services.
The unpredictable nature of business means that losses are an inevitable reality. The good news is the potential tax relief available for those experiencing financial downturns. However, it is essential to understand net operating losses, at-risk rules, and tax loss carry-forwards. With meticulous recordkeeping and expert guidance, companies can strategically and seamlessly claim a small business loss on taxes, optimizing their tax situation and paving the way for financial resilience.