Running a business has many challenges – from developing new products or services to keeping customers. But generating profit is usually the biggest challenge.
If you incur a business loss, know that you’re not alone. Some companies operate at a loss too. Avoid making major changes to your business without looking at how much money is coming in each month and compared to how much you spend.
And don’t worry. We’ll teach you the rules regarding business losses and help you determine if you can get a tax refund if your business loses money in the US. For starters, let’s review the basics of business loss.
What is a Business Loss?
A business loss occurs when the company doesn’t generate enough revenue to cover all expenses associated with the business operation in an accounting period. In other words, the business lost money.
Operation charges include everything from advertising to salaries, supplies, litigation, and depreciation. Unlike other costs, a company doesn’t spend money on depreciation.
Although bleeding money is rarely a good thing, it will turn out to be useful during tax time.
Net Operating Loss (NOL)
It occurs when a business’ allowable deductions are higher than its taxable income in a tax period. The loss can be carried forward to reduce the business’ tax liability in future years via an Internal Revenue Service (IRS) tax provision called loss carryforward.
You can carry forward up to 80% of taxable income, but not for an unlimited number of years. This carryover provision isn’t available to corporations.
A NOL can reduce your tax liability for the current and future years. The idea behind this is to give a form of relief to businesses that suffer a financial loss.
The NOL is calculated on a business expense sheet by subtracting the itemized deductions from adjusted gross income (AGI).
Add any nonbusiness (personal) deductions that are more than nonbusiness income to your adjusted gross income. Include deductions for personal exemptions, IRA contributions, charitable contributions, nonbusiness capital losses, and standard or itemized deductions (not your personal exemption). If the result is still negative, you have a net operating loss.
Let’s say your business has a taxable income of $800,000, a corporate tax rate of 40%, and tax deductions of $900,000. Its NOL would be
$800,000 - $900,000 = -100,000.
The business doesn’t have a taxable income. So, it will not be paying tax for that taxing period. However, let’s assume the business makes a profit the following year worth $200,000.
Taxed at the corporate tax rate of 40%, the business will have to pay $80,000 in taxes. Since there was a net operating loss last in the previous year or taxing period, it can be used to lower the present year’s tax bill.
NOL comes with limitations. For instance, it cannot be used to offset investment expenses and other business expenses.
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How Do Taxes Work if Your Business Loses Money?
As a way of helping small business owners continue with their operation through difficult years, the US Federal agency, the Internal Revenue Service (IRS), allow them to reduce their taxable income using business losses.
So, Will I Get a Tax Refund if My Business Loses Money?
Yes, you can get a tax refund (for past and future tax years) if your business loses money. You can get a refund for all or a portion of your tax liabilities from the past years. You usually receive that refund quickly, usually within 90 days.
However, whether or not you can claim a tax refund on your tax return depends on how your business is categorized.
Suppose you run a sole proprietorship, a partnership, a limited liability company (LLC), or an S-Corp. In that case, your business losses are typically deducted from your personal income taxes.
For example, if you’re a sole proprietor, you may deduct any business loss from your other income. It could be from a job, a spouse's income, or an investment income.
C Corporation Cannot Deduct Business Losses
A C-Corp means that the business’ income and expenses are handled separately from the personal finances of the owners.
Hence, a C-Corp’s business losses are typically not claimed on the personal tax return.
After making an accounting entry for tax refund funds, the inflow of cash can help you financially get back on your feet.
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How much business loss can you claim on taxes?
Starting the tax year 2021, you can take a business loss of up to $262,000 if you are an individual and $524,000 for a joint tax return. [1]
Any loss of over $262,000 for a single taxpayer or $524,000 for a joint return is considered an excess, and such an amount cannot be considered a loss on the tax return for the taxing period.
Each business is different, so the amount of business loss they can claim on their tax return will also depend on their business type, the risk involved in their business, and other factors.
Loss limits don’t apply to corporations.
To determine if you can take the full amount of the allowable business loss, apply the at-risk rules and the passive activity rules.
At-risk rules limit your business losses to the amount at risk in the activity. These limits apply to certain closely-held C corporation owners carrying a trade or business for profit, S corporation shareholders, and partners. [2]
Meanwhile, the passive activity rules limit business loss deductions. It relates to a business owner who doesn’t participate in a business on a continuous, regular, or substantial basis. In short, this business owner is a shareholder or an investor but isn’t active in the business.
How Many Years Can I Take a Loss on My Business?
There’s no limit to how many years your business can take a loss. Many businesses cannot assume a loss for consecutive years because their money runs out.
Yet, if you can sustain your lifestyle and cover your costs, there’s nothing wrong with maintaining a loss year-over-year. It may, however, cause harder looks from the IRS, who may classify your business only as a hobby because there’s no advancement toward a profit motive.
Reporting Business Losses
Use the IRS Form 461 to calculate business loss limitations and report them on your personal tax return. This form collects information on your total loss and income for the year from different sources.
There, you’ll deduct the business loss and compare it to your excess loss limits to determine if it will be limited.
File your own taxes or hire someone?
Doing your own taxes takes patience and time. If you don’t have either or you’d rather use it to focus on more important things, it may be worth hiring a tax professional.
Hall Accounting Company provides accounting services, including, but not limited to:
Bookkeeping,
Bank Reconciliations
Accounting Assistance
Sales & Payroll Taxes,
Financial Assessment
Weekly, Monthly, or Quarterly Reports
Software Consultations,
Accounts Payable & Receivable
Its experienced staff develops tax strategies so you can benefit from the new tax laws and legislation while minimizing your current and future tax liabilities and identifying tax planning opportunities.
The Bottom line
Claiming business losses doesn’t have to be as intimidating. With the right professional, guidance, and software on your side, you can surely take on anything.
Let us take the work off your hands of claiming against a business loss. Hall Accounting Company provides custom accounting solutions to small businesses, that allow you to focus on what you love.