How Long Do QBI Losses Carry Forward?
Understand the rules for carrying forward Qualified Business Income (QBI) losses to manage your tax obligations effectively.
The Qualified Business Income (QBI) deduction, established by the 2017 Tax Cuts and Jobs Act (TCJA), offers a tax benefit for eligible self-employed individuals and owners of pass-through businesses. This deduction allows taxpayers to reduce their taxable income by up to 20% of their QBI. While the QBI deduction typically lowers tax liability, business operations can sometimes result in net losses. These losses, if qualified as QBI losses, are handled specifically for tax purposes. This article explains how these losses are determined, carried forward, and the necessary records to maintain for compliance.
Understanding Qualified Business Income and Losses
Qualified Business Income (QBI) represents the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business. This includes income from sole proprietorships, partnerships, and S corporations. Certain items are excluded from QBI, such as capital gains or losses, dividends, interest income, and income earned outside the U.S. Wages and guaranteed payments made to partners and S-corporation owners are generally not included in QBI.
A QBI loss occurs when total qualified business deductions exceed total qualified business income for a tax year from all aggregated qualified trades or businesses. If a taxpayer operates multiple businesses, the QBI from each business is first determined individually. Any qualified business losses from one business must then offset QBI from other businesses.
If, after this netting process, a taxpayer’s overall net QBI from all qualified trades or businesses is negative for the tax year, this results in an overall QBI loss. This negative QBI amount means the taxpayer will have a zero QBI deduction for the current year. This net loss then becomes a QBI loss carryforward, impacting future tax years.
Applying QBI Loss Carryforwards
If a taxpayer has an overall QBI loss for a tax year, this loss is carried forward to the next tax year. This carryforward is treated as a negative QBI amount arising from a separate trade or business in the subsequent year. QBI losses can be carried forward indefinitely. These losses remain available until fully utilized by positive QBI in future tax years or the qualified business ceases operation without sufficient positive QBI to absorb the loss.
When a QBI loss is carried forward, it reduces any positive QBI generated in that later year. This reduction occurs before other limitations on the QBI deduction are applied for that year. For instance, if a taxpayer has a $5,000 QBI loss carryforward and generates $7,000 in positive QBI the following year, the $7,000 positive QBI is first reduced by the $5,000 loss carryforward, resulting in $2,000 of QBI eligible for the deduction.
If the carried-forward loss exceeds the positive QBI in the subsequent year, the remaining loss continues to be carried forward to future years. This process ensures the loss is fully accounted for against future qualified business income. These carryforward losses are specifically for the QBI deduction calculation and do not impact other tax provisions like the deductibility of losses for self-employment tax purposes.
Record Keeping for QBI Losses
Maintaining records is important for all income and expenses related to qualified trades or businesses, especially when a QBI loss is incurred and carried forward. Comprehensive documentation supports the accuracy of reported losses and their subsequent application. This includes detailed profit and loss statements and balance sheets for each business activity.
Taxpayers should retain invoices, receipts, and bank statements that substantiate all income and expense transactions. Copies of relevant tax forms, such as Schedule C (for sole proprietorships), Schedule K-1 (for partnerships and S corporations), and Form 8995 or 8995-A (Qualified Business Income Deduction), are necessary. For certain activities, like rental real estate, contemporaneous records detailing service hours, descriptions of services, dates, and who performed them are required if relying on specific safe harbor provisions.
Diligent record-keeping substantiates the QBI loss in the year it occurred and supports the proper application of the carryforward in subsequent years. These records are important in the event of an audit or inquiry by the IRS, as they provide the necessary evidence to demonstrate compliance with tax regulations. Proper documentation helps ensure the QBI loss carryforward is correctly calculated and applied, maximizing any future tax benefits.