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Claiming Business Loss on Your Tax Return

Business Finance

Claiming Business Loss on Your Tax Return

Updated: Jun 30, 2020

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If there’s one thing that has become clear in 2020, it’s that it hasn’t been an easy year for most small businesses. The onset of the COVID-19 pandemic, followed by an economic slowdown due to lockdown measures, has completely crippled cash flow for many business owners. The U.S. economy is mired in a recession, officially, with millions of Americans lining up for unemployment benefits and business owners patiently waiting to open their doors in the right way.

Fortunately, there has been relief in the way of government stimulus, including business loans by the Small Business Administration, which have helped many entrepreneurs to stay afloat while cash flow has all but come to a stop. 

But if ever there was a time that you should consider claiming a business loss on taxes, this is probably the year to do it. A net operating loss is a tax provision that happens when your deductions for that year surpass your income for the same period. And if you happen to be a member of the business loss club, don’t fret. There’s a COVID-fueled government stimulus program for that, too.  

Claiming a business loss on taxes is common

If you think that you could fall into the business loss camp this year, you wouldn’t be the first one. Back in 1995, Donald Trump took a loss of more than $900 million on his income tax returns. Of course, that was bigger than usual, at roughly 9,000-times the average loss amount claimed at the time. But it grew into a trend when business owners far and wide realized that they could redirect losses to offset their taxable gains in other years. 

In more recent data, however, more than a million filers claimed a net operating loss deduction in the year 2014, which was the highest it’s been since the IRS began tracking the results. In that year, the average business loss amount was just over $163,000. Something to keep in mind was there was no economic crisis during 2014, so chances are that record could have some competition in 2020. 

While operating a business is not the only way to experience an NOL, it’s the most common way. You’ll want to be sure you’re up on your record-keeping skills. You can expect to maintain records for the tax year in which you went through the loss, for the next three years or there-after you used the carry forward feature – whichever is later. Plan to include any relevant documents to the Form 1045 or 1040-X. 

How can you write off a business loss on your taxes?

If you’re wondering if you fit the bill for claiming a business loss on your taxes, keep the following parameters in mind: 

  • If you run your small business as an LLC, S-corp, sole proprietorship, or partnership, losses are generally passed through the business to your personal tax returns. Also, they are deducted from your personal income to offset that amount. 
  • If you run a C-corp, the loss cannot be passed through to your personal tax returns and instead is inherent with the corporation. 

But if you’ve got what’s known as an excess business loss, it’s characterized as an NOL carryover. An NOL carryover is where the carry-forward rule comes into play for claiming a loss on taxes. The loss can be used to counteract some or all of your taxable income in the future until it’s depleted. 

Basic business loss example

All this talk about taxes is begging for an example. Let’s say a company generates $2 million in revenue but faces twice that amount in expenses. That business seemingly has an NOL of $2 million (the difference between the expenses and revenue).  

Now it doesn’t matter whether it’s a major corporation, like Lyft, or a mom and pop shop. So if your business experienced a loss and generated income in recent years, you’ll want to listen up because you could be about to come into a refund. (The previous example is a simplified illustration, as the actual IRS filing is more complex. Form 461 for 2020 will be released in early 2021.) 

That was then; this is now 

In 2017, sweeping policy changes were introduced to the tax law that added more sting to claiming a business loss on taxes. These changes can be summed up as follows

  • You could generally only carry an NOL occurring after 2017 forward. Previously, you could also carry it back to the past years.
  • Farmers and certain insurers are the exception and could carry back some losses for two years. 
  • As of year-end 2017, the NOL deduction was capped at 80% of taxable income. 

COVID-19 rules for claiming a loss on taxes

Then came the pandemic, and the IRS once again tweaked those rules under what’s known as the CARES Act, more famously associated with the Paycheck Protection Program. The NOL provisions were tucked into the piece of legislation as well, and they are being cheered: carrybacks are back, and the deduction cap for claiming a loss on taxes was lifted. Here are some of the highlights: 

  • Business owners who experienced an NOL in the 2018-2020 period can carry those losses back to slash the taxable income earned in the half-decade leading up to the year that the NOL occurred. The five-year rule is applicable for 2018-2020. 
  • The taxable income cap that was established in 2017 is history for now. This means you should be able to use business losses to slash your full taxable income for the 2018-2020 period.  
  • Carry-forwards still apply indefinitely. 

In a nutshell, if your business was profitable pre-COVID, but then you swung to a loss as a result of the economic slowdown, you should be able to carry those losses back for up to five years and recover income taxes you doled out during that period. This could provide a much-needed boost to cash flow. Businesses operating at a loss in recent years or startups without enough of a performance history might not qualify for these provisions. 

If your business experienced a loss in the 2018-2020 period, those losses could be carried over to the future starting in 2021. 

More to come for those hoping to claim a business loss on their taxes? 

Policymakers are still debating further stimulus measures as the U.S. economy crawls back to growth amid the easing of lockdown measures. As a result, there could be more changes for those hoping to claim a loss on their taxes in the COVID era. 

If you’ve had any SBA loan forgiveness through the CARES Act, remember that it is not considered taxable income. Be sure and tap into a certified tax professional’s expertise to see how you can make the most from claiming a business loss on your taxes. 

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