How to Claim Business Losses on Tax Return
Running a business can be a challenging task, and sometimes businesses face financial difficulties resulting in losses. The good news is that these losses can be claimed on your tax return, helping to offset your taxable income and potentially reducing your tax liability. Here’s a step-by-step guide on how to claim business losses on your tax return.
1. Determine your business structure: Before claiming business losses, identify the legal structure of your business. Different rules apply to sole proprietorships, partnerships, corporations, and other business entities.
2. Understand IRS rules: Familiarize yourself with the Internal Revenue Service (IRS) rules regarding business losses. Refer to IRS Publication 535, Business Expenses, for specific guidelines on how to calculate and claim business losses.
3. Calculate your business loss: Determine the amount of your business loss by subtracting your total business expenses from your business income. If your expenses exceed your income, you have a net operating loss (NOL).
4. Carry back or carry forward: Decide whether to carry back the NOL to offset prior years’ taxable income or carry it forward to offset future taxable income. The CARES Act allows businesses to carry back NOLs generated in tax years 2018, 2019, and 2020 for up to five years.
5. Amend prior tax returns (if applicable): If you choose to carry back the NOL, file an amended tax return for the applicable years. The IRS provides Form 1045, Application for Tentative Refund, for individuals, and Form 1139, Corporation Application for Tentative Refund, for corporations.
6. Complete Schedule C or other relevant forms: Use Schedule C, Profit or Loss from Business, to report your business income and expenses on your individual tax return. For partnerships and corporations, utilize the appropriate form, such as Form 1065 or Form 1120.
7. Deduct the NOL: Deduct the NOL amount from your taxable income when completing your tax return. This will reduce your overall tax liability.
8. Keep proper documentation: Maintain accurate records of your business income, expenses, and any other supporting documents to substantiate your NOL claim in case of an IRS audit.
1. Can I claim business losses if I operate as a sole proprietor?
Yes, as a sole proprietor, you can claim business losses on your Schedule C when filing your individual tax return.
2. Are there any limits on the amount of business losses I can claim?
No, there are no limitations on the amount of business losses you can claim. However, the IRS may scrutinize large losses more closely.
3. Can I claim business losses if my business is a hobby?
No, the IRS generally does not allow deductions for hobby losses. To claim business losses, your activity must be conducted with the intent to make a profit.
4. What happens if my business losses exceed my income?
If your business losses exceed your income, you have an NOL. This can be carried back to prior years or carried forward to offset future taxable income.
5. Can I claim business losses if I have a side business in addition to my regular job?
Yes, you can claim business losses from your side business on your tax return. However, the IRS may scrutinize such claims to ensure the activity qualifies as a business, not a hobby.
6. Do I need professional help to claim business losses?
While professional assistance is not mandatory, it’s advisable to consult a tax professional or CPA for complex tax situations or if you’re unsure about the IRS rules and regulations.
7. Can business losses be used to obtain a tax refund?
Yes, if your business losses result in a negative taxable income, you may be eligible for a tax refund.
8. Can I carry back NOLs indefinitely?
No, under the CARES Act, NOLs generated in tax years 2018, 2019, and 2020 can be carried back for up to five years. However, previous rules allowed NOL carrybacks for only two years.
Remember, claiming business losses on your tax return can significantly reduce your tax liability and provide valuable financial relief. Ensure you understand the IRS guidelines, keep accurate records, and consult a tax professional if needed.