The business loss calculation for your corporation is a very important one and should be calculated properly or you could end up owing money instead of getting a refund. This article will show you a step by step approach to this calculation.
When a business is affected by certain events, it might lead to financial losses. Sometimes those losses can be recovered through State and Federal tax credits. Whatever the case may be, it is important to know how to recover the losses properly and not run into any issues, like being audited or denied credit.
To calculate business loss for taxes, you will need to first calculate your income before expenses.
For example, let’s say that you made $50,000 in revenue from your business. If you spent $30,000 on operating expenses, then your net profit would be $20,000.
You would then take this number and subtract it from your total losses for the year. For example, if you lost $15,000 in other investments during the year, but only incurred $5,000 worth of expenses for running your business, then your net loss would be $10,000 (which is calculated by subtracting the $15,000 from the $20k).
This amount should be entered on line 21 of Schedule C of Form 1040 and carried over onto line 4 of Form 8949 and then again onto line 13 of Form 1120S.
How To Claim a Business Loss on Taxes
No business owner wants to have a loss, but losses aren’t entirely a negative thing. They can yield some benefits in certain situations. You may be able to recover losses to offset income from other sources and cut your tax bill. This article discusses how to deal with a business loss, including limits to losses and how to carry over excess losses to future years.
Key Takeaways
- Losses for small businesses are included in the owner’s personal tax return.
- Business owners may be able to use business losses to offset other income in a tax year.
- You will need to calculate net operating loss by subtracting non-allowed deductions to determine the amount of the loss.
- The business loss you can take in a year may be limited, but you may be able to carry over some of the excess loss to offset profits in future years.
Business Losses and Your Personal Taxes
Your small business may have several types of losses, depending on the type of income. These include:
- Net operating losses from normal business operations
- Capital losses on the sale or exchange of business property
Both types of losses affect your personal income taxes because most small businesses pay taxes through their personal tax return. These types of businesses include sole proprietorships, limited liability companies (LLCs), partnerships, and S corporations.
Note
Corporations calculate net operating losses the same as other types of businesses, but a corporation takes different deductions, uses different forms, and must use carryovers differently.
A business loss from operations can offset other income to give the owner a lower tax bill. For example, a business owner’s Schedule C might show an operating loss of $10,000, and the owner’s other taxable income is $45,000. If the total amount of the business loss is allowed, the owner’s net taxable income would be $35,000.
Capital losses result from the sale or exchange of a capital asset, like a business vehicle, equipment, or a building, or an intangible asset like a patent or license. You can only deduct the amount of losses up to the amount of the capital gains (or $3,000 if the net loss exceeds $3,000).1
Deductible Business Expenses
Most small businesses intend to make a profit and are at risk for losses, so they may take all ordinary and necessary business expenses to determine operating profit or loss. These expenses include:
- Advertising and promotion
- Expenses related to having employees
- Fees to professionals and other non-employees
- Insurance
- Interest on loans
- Office expenses
- Cost of company vehicles and travel
- Home office expenses
- Cost of goods sold (COGS) for businesses that sell products
Capital expenses for costs of long-term assets like vehicles, equipment, and furniture are also deductible by spreading out the cost over several years through depreciation.2
Limits on Business Losses
Both operating losses and capital losses may be limited for a specific tax year. These loss limitations are applied to business owners, not the businesses themselves.
Net Operating Loss
If your total deductions for a year, including business tax deductions, are more than your total income for a year, you may have a net operating loss (NOL), which is limited to 80% of the individual’s excess taxable income for that year.3 The excess loss is calculated by starting with the business net income for the year and subtracting any of these non-allowed deductions and losses:
- Capital losses in excess of capital gains
- Gain from the sale or exchange of qualified small business stock
- Nonbusiness deductions in excess of non-business income
- The net operating loss deduction
- The qualified business income (Section 199A) deduction4
Losses from At-Risk and Passive Activities
Business losses may also be limited from at-risk and passive activities may also affect the amount of business loss you can take.
Passive activity means that the business owner didn’t actively participate in managing the business on a regular, continuous, and substantial basis. For example, an owner who rents real estate is considered a passive owner, even if they do participate in management, while a limited partner in a partnership is considered a passive investor.
At-risk rules limit the amount of business loss to the net allowable deductions for the business for the year, including depreciation and tax amortization.
How Loss Carryforward Works
If your net operating loss for a year is limited, you may be able to use all or part of that loss in future tax years through a process called loss carryforward. The amount carried forward is the excess of your NOL deduction over your modified taxable income for the year, subject to the 80% limit for 2021 and beyond. You can’t claim an NOL deduction for the NOL carryover for the current or any later NOL, and your modified taxable income can’t be less than zero.
The calculations for net operating loss and loss carryforward are complicated. Get help from a licensed tax professional for this part of your tax return.
Note
The 2020 CARES Act allowed a special five-year tax carryback for 2018, 2019, and 2020 tax years and eliminated the 80% limit on net operating losses. These special provisions expired on Dec. 31, 2020.53
How To Claim Your Losses
Net income is calculated by adding up all sources of income and subtracting deductions and credits. Complete Schedule C (or other tax form for your business type) and enter the net profit or loss on Schedule 1 of Form 1040 or 1040-SR (for seniors). The information from Schedule 1 is added to income from other sources, and any adjustments to income are included in Schedule 1.
You must also complete IRS Form 461 Limitation on Business Losses. This form adds up all types of losses from various sources, including operating losses and capital losses, adjusts for non-business losses, and runs a calculation for excess business losses.
Note
Form 461 was suspended for 2018, 2019, and 2020 tax years. For your 2021 taxes, be sure you have the 2021 form.
Frequently Asked Questions (FAQs)
How often can I claim a business loss on my taxes?
You can claim a business loss each year, but the amount of your loss in any year may be limited. If your loss in one year is limited, you may be able to carry that loss over to future profitable years. But if you don’t have profitable years in the future, you may not be able to carry over these losses.
Because you are in business to make a profit, several years of loss can be a red flag for the IRS. The IRS guidelines presume you are in business to make a profit if you have a profit in at least three of the last five tax years.6 If you can’t meet this test, the IRS may consider your activities a hobby, not a business, and you may not be able to take business tax deductions.
How much business loss can I claim on my taxes?
To know how much you can claim on operating losses for the year, you must go through several calculations. You will need to know the amounts of business losses from operations, from the sale of business assets, and from other less common types of activities.
First, check to see if your losses might be limited because you might be a passive owner, meaning that you don’t participate actively in your business. This is typically the case for limited partners in a partnership or individuals in rental real estate businesses.
Once you have your net operating loss, you can include all the information about your business losses on your Form 1040. If you can’t take all of your loss for the year, you may be able to carry some of that loss over to future years, through a process called loss carryforward. This is a complicated process, so you should get help from a licensed tax professional.
Running a business at a loss for tax purposes
What operating at a loss means
Operating at a loss is when you’re spending more money than is coming in to the business.
Businesses often operate at a loss temporarily when starting out or in periods of growth. This is okay if you’ve got enough in the bank to cover the costs of running your business until your income picks up.
But if your business is frequently operating at a loss because of slow sales, you’ll need to make some changes to how your business is running. Think about consulting an advisor to help you turn things around.
How to know if you’re operating at a loss
- You don’t have enough money to pay your bills.
- Your bank balance is negative and you don’t know how to get it positive again.
- You’re not selling the amount you needed to in your forecast, eg if your business model is reliant on selling ten cups of coffee a day and you’re selling three.
If you know you’ve got money coming in the future — like a big invoice being paid — that will cover your loss, this is an issue with your cash flow.
You may need to raise or borrow money to cover costs until the payment is made.
What to do if you’re operating at a loss
Try these steps:
1. Reduce your expenses.
- Is there anything you can cut from your spending?
- Can you reduce the amount of drawings you’re taking from the business?
- Try to negotiate better deals from your suppliers.
- Sell assets you’re no longer using.
2. Increase your sales.
- Can you charge more for your product or service?
- How can you sell more of your product or service?
- Can you get more customers?
3. Get advice — an advisor may be able to help you turn it around.
Advice from an accountant or business advisor can help you get your business back on track and avoid trouble ahead.
You may need to spend more on marketing to get more customers.
Test a small amount first — spend $100 and see what your results are instead of spending $1,000 upfront.
Claiming losses at tax time
If you claim a loss in your tax return, you can carry it forward to lower your income in the next tax year — and therefore reduce your tax bill.
Sole traders and partnerships
Report the loss in your Individual tax return(external link) (IR3). Inland Revenue will then let you know the amount that can be carried forward to the next tax year.
If the loss is greater than your income, the difference can be used to lower your taxable income in following years.
How to claim a loss(external link) — Inland Revenue
Companies
In most cases, companies operating at a loss don’t have to pay income tax.
A company may be able to transfer its loss to another company, or carry the loss forward to future years.
To carry the tax loss forward, you’ll need to:
- report it in your company’s Income tax return(external link) (IR4)
- meet the shareholder continuity test — a group of shareholders must have combined voting interest of 49% or more from the beginning of the year the loss was incurred to the end of the year it’s offset.
Companies need to calculate voting interest in a specific way. And groups of companies looking to bring losses forward may be prevented from doing so by being in a ‘market value circumstance’. See Inland Revenue’s When companies make losses(external link) for more details.
If you’re considering bringing losses forward for tax purposes, you should consult a tax adviser. Ask around the people you know for recommendations.
Common mistakes
Avoid these common pitfalls:
- Ignoring the warning signs that you may be in a loss position.
- Not having a plan in place to get back out of it.
- Purchasing things you can’t pay for — if you go to a supplier when you know you can’t pay the invoice, you’re operating in an insolvent position and can be made bankrupt.