Claiming Business Losses Against Other Income
"Can I write off business losses on my personal taxes" is a question a trusted tax professional can address while attempting to mitigate the financial setback you've experienced. Though business losses are never welcome, they can potentially be used to business owners’ advantage to write off other income on their personal tax returns.
Be aware that this is only a tax advantage enjoyed by some business owners. Your business structure and specific circumstances will determine your eligibility for this potential tax saving.
Can I Offset Business Losses on My Personal Tax Return?
You can offset business losses on your personal tax return if your business is structured as a pass-through entity (sole proprietorships, LLCs, partnerships, and S corporations). This is one of the most important tax benefits of LLCs and other pass-through entities.
An overall operational loss in a given year is called a net operating loss (NOL). Though the IRS allows owners of pass-through entities to offset net operating losses on their personal tax returns, the rules surrounding it can be tricky to navigate. This means that it’s easy to make mistakes on your tax return or let potential deductions slip through the net.
Many small and medium-sized businesses turn to trusted experts in tax preparation like our teams in Jacksonville, Florida, and Spartanburg, South Carolina to avoid costly errors and take advantage of every possible way to reduce taxable income.
Partnering with tax experts will help you avoid paying more tax than you need to by exploring all the possible avenues for business deductions. Your accounting team will also keep you compliant while minimizing the financial impact of a downturn in activity.
How to Figure a Net Operating Loss
Figure a net operating loss with the following steps:
1. Calculate Your Taxable Income
For individuals: Begin with your adjusted gross income (AGI) and subtract your standard deduction or itemized deductions. This gives you your taxable income.
For businesses: Start with your gross income and subtract allowable business deductions.
Please note: Passive activity and at-risk rules may limit the deductions to which you're entitled. This applies to investors or shareholders who aren't active in the business or losses resulting from passive activity like rental properties or losses from a trade or business you don't regularly participate in. Include only active income when figuring a NOL.
2. Determine If You Have a Net Operating Loss
If the result from step 1 is a negative number, you may have a net operating loss. However, you will need to consider some adjustments first.
3. Make Adjustments
Making adjustments to figure a net operating loss gets a bit complicated, as certain items are treated differently when calculating a NOL compared to regular taxable income. Here are the main adjustments:
Nonbusiness capital losses: If you have nonbusiness capital losses (losses from selling personal assets like stocks), you can only deduct them up to the amount of your nonbusiness capital gains. Any excess nonbusiness capital losses can’t be used to create or increase a net operating loss.
Nonbusiness deductions: Nonbusiness deductions in excess of nonbusiness income, section 1202 exclusion amounts, NOL deductions, and section 199A deductions cannot be used when figuring a NOL.
Business capital losses: Business capital losses are limited to the amount of your business capital gains when calculating a net operating loss.
4. Calculate the Net Operating Loss
After making the necessary adjustments, you can calculate the NOL. Here's a simplified formula:
Net Operating Loss = Taxable Income (after adjustments) - Allowable Deductions (after adjustments)
If the result is negative, that's your net operating loss.
Net Operating Loss vs Excess Business Loss
Net operating losses and excess business losses are both important for businesses seeking to offset their losses against other income. Remember that a net operating loss simply refers to the amount by which your business's allowable deductions exceed its gross income in a given year.An excess business loss, however, is a specific type of business loss subject to limitations introduced by the Tax Cuts and Jobs Act.
An excess business loss occurs when a business loss surpasses a certain threshold set by the IRS ($305,000 for single filers and $610,000 for married filing jointly in 2024).While net operating losses can generally be claimed for the current tax year and carried forward to offset income in future tax years (with some limitations), an excess business loss is treated as a net operating loss carryforward, meaning it can only be used to offset income in future tax years.
How to Figure an Excess Business Loss
The excess business loss for a single (or married filing separately) taxpayer is calculated as follows for a business with $200,000 in revenue and $600,000 in expenses:
$600,000 (deductions) - $200,000 (income) = $400,000
$400,000 - $305,000 (threshold) = $95,000 (excess business loss)
The excess business loss limitation is likely to stay around until at least 2028. Small business owners of pass-through entities should therefore discuss with a trusted tax professional how to make provisions for it in their tax planning strategy for 2025 and beyond.
How to Deduct Business Losses
The steps to deduct a NOL are different for pass-through entities and corporations. Owners of pass-through entities like sole proprietors, partners in partnerships, members of LLCs, and shareholders in S corporations can generally deduct business losses against their other personal income, subject to certain limitations. Owners of corporations can only deduct a NOL against corporate gains.
Deducting Business Losses for "Pass-Through" Entities
If you operate your business as a "pass-through" entity, your business income and expenses are reported on Schedule C of your personal tax return (Form 1040). If your business expenses exceed your income, resulting in a loss, you can generally deduct that loss against your other personal income (such as wages, interest, or dividends).
Remember that you can only deduct up to the threshold amount ($305,000 or $610,000) in a single year. Business losses in excess of the threshold amount are carried forward to the next tax period.
In the following year, the net operating loss deduction will be subject to an 80% taxable income limitation. You can continue to deduct the NOL up to the 80% taxable income limitation until the NOL has been completely absorbed.
Deducting Business Losses for C Corporations
C corporations are treated as separate tax entities from their owners, so losses stay within the corporation. These losses can be used to offset future corporate profits. Shareholders typically cannot deduct these losses on their personal tax returns.
Get Expert Help to Successfully Navigate NOL Deductions
Claiming business losses against other income is a tax benefit that offers small business owners a silver lining during hard times. Reducing your tax liability will help you keep as much money as possible in your business as you wait for better days.
Navigating the regulations surrounding business loss deductions and other crucial business write-offs is complex. Expert assistance from a tax professional will ensure your business gets everything it deserves.
