Claiming Business Losses on Your Tax Return

Business owner stressed doing paperwork

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Let's say you have a loss in your small business for the year. Can you get a tax refund for that loss? Can you take the loss to reduce your personal taxes? Getting some tax benefit from your business loss depends on several factors, including whether you have other income to offset the loss.

Key Takeaways

  • Limits on business losses affect businesses that pay their business tax through their personal tax return.
  • Corporations can take a business loss, but it doesn't affect shareholders' taxes.
  • Business owners who have limited or no risk or who don't participate in running the business may have limits on their business loss for tax purposes.
  • If your loss is over the limit for one tax year, you may be able to carry forward all or part of that loss to reduce taxable income in future years.

How Much Loss Can a Business Take?

Businesses that are organized as sole proprietors, limited liability companies (LLCs), partnerships, and S corporations can take business losses on their personal tax returns. Loss limits don't apply to corporations. A business loss for the year from operations is called a net operating loss. The IRS imposes limits on business losses in several situations.

Before you determine if you can take the full amount of the allowable business loss, you must first apply at-risk rules followed by passive activity rules.

At-Risk Rules

At-risk rules limit your losses from business to your amount at risk in the activity. These at-risk limits apply to partners and S corporation shareholders and certain closely-held C corporation owners who are carrying on a trade or business for profit. You'll need need to use IRS Form 6198 to compute and report your at-risk situation.

Passive Activity

Passive activity rules also limit business loss deductions. Passive activity relates to a business owner who does not participate on a regular, continuous, or substantial basis. In other words, this person is an investor or a shareholder but isn't active in the business. Passive activity rules apply to rental activities, even if the owner actively participates in the business unless they are a real estate professional. Losses resulting from passive activity can only be deducted up to the amount of income from that business.

The passive activity rules don't apply to Airbnb hosts or hosts on another home-sharing service if they rent out all or part of their home for more than 14 days or 10% of the days they rented at fair market value during the year.

How Excess Loss Rules Work

The excess loss rule kicks in when your total business deductions are more than your total gross income from your business, above a threshold amount of $262,000 for a single taxpayer or $524,000 for a joint tax return, beginning in 2021 and going forward.

To say it more simply, taking any loss of more than $262,000 (single taxpayer) or $524,000 (joint return) is considered excess and that excess amount can't be taken as a loss on your tax return for the year.

Tax Loss Carry Forward Rules

If your business loss is limited for one year by the excess loss rules, you may be able to carry over all or part of the excess loss to a future tax year. Beginning with 2021 taxes, the provisions of the 2017 Tax Cuts and Jobs Act for tax loss carry-forwards are returned in full.

The tax loss carry-back is no longer available. You can still carry a business loss forward to future tax years, but you can no longer carry a net operating loss back to past years.

The amount you can carry forward is limited to 80% of taxable income, but you can go forward for an unlimited number of years. Tax loss carry-forwards are not available to corporations.

Calculating and Reporting Business Losses

To calculate the amount of the loss, you add your business income and subtract business expenses on your business tax return. If your deductible expenses are greater than the income, you have a loss, and you can start the process of calculating a net operating loss (NOL).

To run this NOL calculation, you can take some deductions in full, like rent or office expenses. Other deductions, such as depreciation or home business costs, are limited.

Use IRS Form 461 to calculate limitations on business losses and report them on your personal tax return. This form gathers information on your total income or loss for the year from all sources. You subtract out the business loss and compare it to the excess loss limits to see if your losses will be limited.

Because the IRS eliminated limitations on business losses for the 2020 tax year, there is no Form 461 for that year. The form is being reissued for 2021. Make sure you have the correct year for this form.

Limitations on Capital Losses

Capital gains and losses are different kinds of losses a business may have on the sale of capital equipment and investments. These losses are handled differently from operating losses for tax purposes.

There's a limit on the amount of capital loss you can claim. If your capital losses are greater than your capital gains, you can claim the excess loss if it is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss on Form 1040 Schedule D.

Getting Help With Business Losses

For details on at-risk rules and passive activity, see IRS Publication 925. See the IRS article on Capital Gains and Losses for more information on capital losses. The Instructions for Form 461 include details on how to complete this form to calculate and report business loss limits.

Because IRS regulations on business losses can be complicated, check with a licensed tax professional if you think you might have a business loss for the year. This is one part of your business tax return you don't want to tackle on your own.

Frequently Asked Questions (FAQs)

How much business loss can I claim on my taxes?

The amount of business loss you can claim on your tax return depends on your business type and also on the amount of risk you have in your business. A loss for the year from small business operations is called a net operating loss (NOL). The NOL is combined with other income, deductions, and credits on the owner's personal tax return.

Can I deduct business losses from personal income?

You may be able to deduct business losses to offset personal income, depending on the amount of the loss and other restrictions. If your loss is less than the limit for the year, you can claim the full amount of the loss against your personal income, including income from employment, Social Security benefits, and investment gains or losses.

If the loss is limited, you may be able to use a procedure called a tax loss carry-forward to claim the loss in future tax years. The tax law limits the amount to be carried over to 80% of your operating losses for the year. If you still have a loss after the first year, you may be able to apply the loss to additional tax years.

Can I claim a loss on my business?

You can claim a loss on your business operations and apply it to your personal tax return if your business is not a corporation. Your loss for the year may be limited if you are a passive investor with no risk for this loss. These limits don't apply to most small business owners, but if you have losses greater than $262,000 as a single taxpayer or $524,000 for a joint return, your losses are limited.

How often can you take a business loss on your taxes?

Businesses can take tax deductions from income if they can show that they are carrying on the business with the intent to make a profit. If they can't show this intent, an activity is presumed to be a hobby, not a business, and it's not eligible to take business tax deductions or to claim business losses.

Each situation is considered a unique case, but the IRS guideline says that an activity is presumed to be a business if it had a profit in at least three of the last five tax years, with no more than two years of losses in that time.