Negative Business Income Tax Deduction
When you have an expense in your business, the IRS almost always lets you claim it to reduce your taxable income. When your business itself generates a loss, though, the IRS offers different rules about how you can deduct the negative income. Generally, you can only use business losses to offset business income, and the rules can be even more complicated depending on your corporate structure.
When you have negative business income, the Internal Revenue Service refers to your loss as a "net operating loss." It allows you to use these losses to balance out profits that your business might earn in other years. The government allows this because it realizes that businesses can be cyclical and that taxing them over a longer time horizon better reflects their actual performance. While both businesses and individuals can experience taxable net operating losses, a business loss can only be used to offset business income. It cannot be used to offset personal income.
When your business experiences a net operating loss, the IRS gives you a 22-year period to claim that loss. If you were profitable in either of the previous two years, you can refile your return for those years and use your loss to reduce your taxes and get a refund. If you can't carry your loss back, you can also save it to carry forward and use at any point in the next 20 years.
While the rules are relatively simple for sole proprietorships and single-owner limited liability companies, partnerships and S corporations send their operating losses back to their individual owners. In a partnership, partners get allocated shares of the loss based on the value of their ownership stake in the company, which may be different from their share of the company's capital. S corporations distribute operating losses to shareholders on the basis of the original value of their shares and any loans that they paid into the company.
C corporations are their own entity for tax purposes. This means that any net operating losses they generate stay with their returns. You can use a corporate net operating loss to offset income two years back or 20 years forward, but you cannot carry it over to a personal return or use it to offset profits from another business entity, unless that entity is a subsidiary of the corporation with a loss.
The rules governing net operating losses and how to allocate them are complicated. Furthermore, deciding whether to carry the loss back or forward can also be a challenging strategic decision. While it's always a good idea to have a certified public accountant help you with business taxation issues, it becomes particularly important when you are dealing with negative business income.