By Fraser Sherman Updated February 18, 2021
Running your company in the red has one potential upside when tax time rolls around. Not only do you not have any business profits to pay tax on, but you can also deduct your losses from your other income. If you keep doing this year after year, though, the Internal Revenue Service may declare your business is a hobby and prohibit you from deducting expenses.
In a five-year period, you can claim a business net loss up to two years without any tax problems. If you report operating losses more frequently, the Internal Revenue Service (IRS) might rule your business is only a hobby. In that case, you'd have to report the income but couldn't write off any expenses.
IRS Business Loss Rules
According to the IRS, you report your business income on Schedule C, subtract your expenses and end up with a net profit or loss. You write the result on Schedule 1 and then subtract it from your other income on your 1040. For example, suppose your spouse's salary is $88,000 while your start-up business lost $16,000 this year. If you're filing jointly, that reduces your total income to $72,000, which also lowers your tax liability.
Claiming a business loss on your tax return like this is legal. However, it only works if you own a pass-through business that lets you claim business income as personal income. Business structures such as a sole proprietorship or partnership do this, the Tax Policy Center explains. If you set up a C-corporation, however, it pays its own taxes, separate from yours.
It's possible your business losses plus your other deductions will leave you with a net operating loss, the IRS points out. For example, imagine your startup lost $76,000. You're filing jointly, which for tax year 2020 gives you a $24,800 standard deduction. Subtracted from your spouse's $88,000 income, that gives you a net tax loss of $12,800. You can subtract that loss from previous years' income to get an extra refund or claim it as a write-off in future years when you're back in the black.
Business Loss Deduction Limit
Claiming a business loss on your tax return isn't something you can do year after year. Staying in the red might be good for cutting your taxes, but the IRS advises you have to show a profit at least three out of the last five years, counting the current year. If you claim a business loss three years in a row or three nonconsecutive years out of five, the government assumes you may have a hobby, not a business.
If you've only been in business two years and you've shown a loss in both, you can file Form 5213 to defer an IRS decision until five years have passed. Provided the next three years show a profit, you're in good shape. If you end up with less than three out of five years of profitable business, the IRS can disallow any of your claimed losses for the five years.
The IRS business loss rules still allow you to write off your red ink if you can show you are working to make the business pay. Factors the government considers include: the losses were for reasons beyond your control, you can reasonably expect to be in the black in the future, and you're putting in time and effort to make your company profitable. Otherwise, according to H&R Block, you have to report the income, but you can't deduct any related expenses.
FAQs
Claiming a business loss on your tax return isn't something you can do year after year. Staying in the red might be good for cutting your taxes, but the IRS advises you have to show a profit at least three out of the last five years, counting the current year.
How often can you claim a loss on your business? ›
The IRS allows you to claim business losses for three out of five tax years. Afterward, it may classify your business as a hobby, making it ineligible for tax deductions.
What is the IRS limit on business losses? ›
Such excess losses should be determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services of an employee. Threshold amount. For 2023, the threshold amount is $289,000 ($578,000 for taxpayers filing a joint return).
Can an LLC report a loss every year? ›
Yes, LLC losses flow to your personal return and may carry forward to future years. Net operating losses carry forward indefinitely but are limited to 80% of the taxable income in the year you claim them.
How many years can you carry forward business losses? ›
U.S. Federal NOL Carryforward Provisions
At the federal level, businesses can carry forward their net operating losses indefinitely, but the deductions are limited to 80 percent of taxable income.
How much loss can I claim per year? ›
Key Takeaways
You can use capital losses to offset capital gains during a tax year, allowing you to remove some income from your tax return. You can use a capital loss to offset ordinary income up to $3,000 per year If you don't have capital gains to offset the loss.
Do you get money back if your business takes a loss? ›
However, if your business has what is classified as an extraordinary loss, you could even get a refund for all or part of your tax liabilities from the previous year. Or, in the case of limited losses, you may be able to carry the loss forward into subsequent tax years.
Does a business loss trigger an audit? ›
Claiming Business Losses Year After Year
If you claim a business loss each time you file your tax return, the IRS may audit you.
How many times can you claim LLC? ›
There is no limit on the number of years you can claim the credit. The credit is worth up to $2,000 per tax return. The LLC is a nonrefundable credit, which means it can only reduce a person's tax liability to zero and no part of the credit can be issued as a refund.
Can LLC losses offset a W-2 income? ›
The income and expenses of the LLC are reported on Schedule C of your personal tax return (Form 1040). If your LLC has a net loss (i.e., the expenses exceed the income), you can use that loss to offset other income you may have, such as W-2 income.
Capital losses that exceed capital gains in a year may be used to offset capital gains or as a deduction against ordinary income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.
How many years can a business go without filing taxes? ›
If you still haven't filed your tax return after three years, the IRS withholds your refund, which means you're no longer eligible to receive it.
What is the excess business loss rule? ›
An excess business loss is the amount by which the total deductions attributable to all of your trades or businesses exceed your total gross income and gains attributable to those trades or businesses plus a threshold amount adjusted for cost of living.
Can you write off more than you make? ›
If your deductions exceed income earned and you had tax withheld from your paycheck, you might be entitled to a refund. You may also be able to claim a net operating loss (NOLs). A Net Operating Loss is when your deductions for the year are greater than your income in that same year.
Can loss from business be carried for years? ›
If losses under business or profession (Non-speculative business) are not fully adjusted in the same financial year in which losses were incurred, they can be carried forward to the next 8 assessment years.
How many years can you show a loss on a farm? ›
It is also important to note that there is a limit for the years of losses that can be reported before it gives the IRS a red flag. “An agriculture business needs to show profit three out of every five years or two out of every seven years if it is a horse business,” he noted. “Scale is not a factor.”
How many years can I claim business expenses? ›
This means you can spread the deduction of these expenses across 15 tax years, starting with the year your business begins operations.
