Most business owners would agree that a business loss is a bad thing- but it doesn’t have to be entirely negative. You may be able to use your business losses on your personal taxes to reduce your tax obligations on income from other sources. Learn how to deduct business losses when filing taxes.
If your business is located in Southeast Wisconsin, let Nolan Accounting handle your financials. We have the experience and expertise to help with tax prep, payroll, general accounting, and bookkeeping.
Here’s what you need to know about deducting business losses when filing your taxes.
Types of Business Losses
There are two primary types of business losses that you may have:
- Net operating losses
- Capital losses
Both have an impact on your personal taxes because most small business owners pay taxes through their personal returns, including LLCs, S-corps, sole proprietorships, and partnerships.
An operations loss can offset other income. For example, if a business owner has an operating loss of $10,000 and their other taxable income is $45,000, the loss reduces that to $35,000.
A capital loss can occur from the sale/exchange of a capital asset. You may only deduct up to the amount of the capital gain, with a limit of $3,000.
Limits on Business Losses
Both types of losses may be limited to a specific tax year. The limitations are applied to the owners of the business, not the business itself.
Net Operating Loss
If your total deductions are more than your total income, you may have a net operating loss of 80%. The excess loss is calculated by taking the net income and subtracting the following non-allowed deductions/losses:
- Capital losses
- Non-business deductions
- Net operating loss deduction
- Gain from sale/exchange of qualified business stock
- Qualified Business Income deduction
Losses from Passive/At-Risk Activities
Losses due to passive and/or at-risk activities may limit the amount of business loss you can take.
Passive activity means that the owner was not actively involved in managing the business. For example, a business owner that rents out property is passive- even if they are actively involved in management. A limited partner is considered a private investor.
At-risk activity rules limit business loss to the net allowable deductions for the year, including tax amortization and depreciation.
How to Claim Losses
In order to deduct business losses, first calculate your net income by adding up all of your income sources and subtracting any credits and deductions. Complete the appropriate tax form for your business type and enter the net profit/loss on Schedule 1 of Form 1040 or 1040-SR. Adjustments to income are included in Schedule 1 and the information from this form is added to other sources of income.
You will also need to complete Form 461, Limitation on Business Losses, from the IRS, which adds up all losses, adjusts for non-business losses and calculates excess business losses.
Let Nolan Accounting Help with Tax Prep
If your business is located in Southeast Wisconsin, let Nolan Accounting help with your tax prep and other accounting needs. By letting us take care of these things, you can be free to manage other aspects of your business.