How to Report a Business Loss on Taxes
Navigating a business loss on your tax return requires understanding how it can offset other income and what rules may affect your deduction.
When a business spends more money than it earns in a tax year, it incurs a business loss. The process involves calculating the loss, using the correct government forms for your business structure, and understanding rules that may limit the amount you can deduct in a given year.
Calculating Your Business’s Net Loss
Calculating a business loss follows a straightforward formula: subtract total deductible expenses from total business income. If the expenses are greater than the income, the result is a net loss. Business income includes all revenue from normal operations, such as sales of products or services, and other income like awards or gains from the sale of business assets.
The next step involves tallying all ordinary and necessary expenses incurred in running the business. Common deductible expenses include the cost of goods sold, employee salaries, rent, utilities, marketing, and professional fees. Maintaining meticulous records of these expenditures is foundational for an accurate loss calculation and for substantiating the deductions if the tax authorities inquire.
Required Forms for Reporting a Loss
The tax forms required to report a business loss are dictated by its legal structure. Each entity type has a designated form where the net loss is calculated and reported to the IRS.
Sole proprietorships and single-member LLCs use Schedule C (Form 1040), Profit or Loss from Business. You report all business income and deduct expenses on this form. The resulting net loss is then carried to Schedule 1 of the owner’s personal Form 1040, where it can offset other sources of income.
Partnerships and multi-member LLCs file Form 1065, U.S. Return of Partnership Income. This is an informational return, as the partnership itself does not pay income tax. The net loss is calculated on Form 1065 and allocated to the partners, who each receive a Schedule K-1 detailing their share of the loss to report on their personal Form 1040.
S corporations use Form 1120-S, U.S. Income Tax Return for an S Corporation. The corporation calculates its net loss on this form, and the loss is passed through to the individual shareholders. Shareholders receive a Schedule K-1 indicating their portion of the loss, which they then report on their personal tax returns to offset other income.
C corporations are separate tax entities from their owners and report a net loss on Form 1120, U.S. Corporation Income Tax Return. Unlike pass-through entities, this loss is not passed on to shareholders’ personal returns. The loss is retained within the corporation and can be used to offset its own income in other years.
Understanding Loss Limitations
Even after a business loss is calculated, the amount you can deduct in the current year may be restricted by several IRS rules. The three primary limitations are the at-risk rules, the passive activity loss rules, and the excess business loss limitation.
The at-risk rules stipulate that you can only deduct losses up to the amount you are personally at risk of losing in the business. This amount includes the cash and property you have contributed, plus any debts for which you are personally liable. If a loss exceeds your at-risk amount, the excess is carried forward to future years, becoming deductible only when you increase your at-risk basis.
Passive activity loss rules restrict deductions for owners who do not materially participate in their business operations. Material participation is defined by the IRS through several tests, such as working more than 500 hours in the business during the tax year. If you do not meet these tests, your involvement is considered passive, and you can only deduct passive losses against income from other passive activities, not against active income like wages.
The excess business loss limitation places a cap on the total net business losses an individual can deduct in a single year against non-business income. For 2025, this inflation-adjusted threshold is $313,000 for single filers and $626,000 for married couples filing jointly. Any business loss that exceeds this threshold is disallowed for the current year and is treated as a Net Operating Loss (NOL) that can be carried forward.
Utilizing a Net Operating Loss (NOL)
When a business loss is limited or exceeds all of your other income for the year, it becomes a Net Operating Loss (NOL). An NOL is a tax attribute that can be used to reduce your tax liability in subsequent years. The rules governing NOLs determine how and when you can apply these carried-over losses.
Under current tax law, NOLs arising in tax years after 2020 are carried forward indefinitely. There is no longer a carryback provision for most businesses, meaning you cannot use the loss to amend prior-year returns for an immediate refund.
When you carry an NOL forward to a future year, its use is subject to a specific limitation. The NOL deduction is limited to 80% of your taxable income in that future year, calculated before the NOL deduction itself. For example, if you have an NOL carryforward of $100,000 and your taxable income in the next year is $80,000, you can only use $64,000 (80% of $80,000) of the NOL to offset that income. The remaining $36,000 is carried forward to subsequent years, subject to the same limitation until used.