How Does Claiming Business Losses on Personal Taxes Work?
For many, working from home, freelancing, or running their own business is uncharted territory. It’s exciting but frightening and intimidating.
Many questions come with these activities: What do I need to do? Who do I need to talk to? Who should I market my products or services to? Should I hire employees? The questions are never-ending.
One very confusing aspect of running a business revolves around filing taxes. Tax time has always been stressful for people, but with all of the changes in the last year, it is even more stressful than ever. More and more people are working from home, and tax rules have been adapted to suit these changes.
It’s normal for tax laws to change consistently, so it is no wonder that so many people are left asking questions, including those surrounding the topic of claiming business losses on personal taxes. Below we share what we know to help you prepare better for this tax season.
Defining a Business Loss
What exactly is a business loss? A business loss is very simple to understand. It means that your expenses cost more than the money you are bringing in.
It is the same as when your household bills and the home supplies you need cost more than your paycheck. The only difference is that with a business loss, the expenses and income are explicitly connected to your business- even if it is a home business.
Claiming Business Losses on Personal Taxes
If this is your first time claiming business losses on personal taxes, you might be confused and feel uncertain in many ways. One common question is this: Can I claim business losses on personal taxes?
The answer is yes- it’s actually a widespread practice. It has been since before all of the changes this year. There are just specific requirements that need to be met, and the filing process must be appropriately handled. (Don’t worry. We’ll get into all of that.)
Type of Business
Whether or not you can claim business losses on your personal tax return depends a lot on how your business is categorized. If you run any of the following, your business losses are typically deducted from your personal income on your taxes.
Sole proprietorship
Partnership- If you have a partner, you can deduct your part of the business losses from your personal income, and your partner can deduct their share on their taxes.
LLC
S-Corp
On the other hand, a C-corp means that the business’s income and expenses are handled separately from the owner’s personal finances. Therefore, business losses typically are not claimed on personal taxes with a C-corp.
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Business Loss Deductions
If you have a sole proprietorship, partnership, LLC, or S-corp, you can claim some of your business losses on your personal taxes. However, the IRS does not typically allow business owners to deduct every expense. Usually, you can deduct any expenses explicitly related to your rent or mortgage, utilities, and supplies.
However, there are some limitations regarding things like business use and depreciation. Deductions such as those can only be taken to make your income and expenses match. It can not be used to make your costs exceed your income.
For instance, I own my own business, which I run from a corner of my home. Typically, I can claim the following expenses:
A portion of my Internet bill
My computer, printer, and printer ink
Paper, pens, highlighters, and so on
All of that is pretty straightforward, but depreciation and such can get confusing. Let’s say that my expenses for the year are $3,000, and my income is $2,500. These are minimal numbers, but we’re keeping it simple.
With those numbers, my business loss would equal $500. I can claim a portion of my home and depreciation on my computer if I choose, but I can only claim $500. It does not matter how much of my house I actually used or how much my laptop depreciated. I can only claim $500 to make my income and expenses equal. If my business loss was $1,500, though, I could claim up to $1,500 for those things.
Again, this is only the case with certain deductions, like depreciation. Most expenses and supplies can be claimed fully. Tax management software or professional services can typically help you straighten all of this out.
If you find yourself in a position to be claiming business losses on personal taxes, you can do so on your tax return on a “Profit or Loss From a Business.” The amount here will be subtracted from any other income, investments, or other employment.
Net Operating Loss
If you subtract your business loss from gross income and end up with a negative number, this means that you have a net operating loss (NOL). To calculate your NOL, there are a few steps. You start by determining your adjusted gross income before deducting either the standard or itemized deductions. After determining that total, you must add back in and capital losses that are more than your capital gains and any non-business deductions that exceed your non-business income.
For those with a Net Operating Loss, you can apply it to your current, former, or even future returns to minimize your tax burden. Filers are limited to claiming no more than 80 percent of the taxable income as an NOL, so you may not be able to claim it all at once. However, you can carry it forward to as many future tax seasons as necessary until it is fully claimed.
Sounds complicated, right? It can be, but it does not have to be. Gone are the days that you have to pour over paperwork for hours and hours and fill in tax forms with a pen- unless you just like the traditional method. Fortunately, there are plenty of tax services and tax preparation software to help us mere mortals file our taxes.
Filing Your Own Taxes VS Hiring Someone
When you face a new tax situation- such as becoming a business owner- you might be wondering whether it’s best to hire a tax professional to file your tax or to file them yourself. The truth is that neither is the right answer for everyone, but the following might help you decide.
For years, I have been filing my own taxes. The first two years were a bit overwhelming because it was all pretty new. It took some time to get accustomed to it all.
If I’m honest, the first year, I spent an entire day obsessing over whether or not I entered everything correctly before I finally submitted them. I then spent the next several weeks scared I did something wrong.
However, it did ease up over time. Now, I can complete it all in about an hour: entering my information, obsessing, and submitting them. I know, you would think after almost ten years, I would not obsess so much anymore. It’s a character flaw.
When You Should Consider to Hire a Professional
The point I want to make with all of this is to be clear that anyone can file their own taxes with the right tax management software. However, if you are facing something new- like starting your own business and claiming business losses- you might seriously consider using professional tax services.
It’s not that you cannot do it- you most certainly can. A tax manager, though, is experienced in handling most tax situations, so they can do it faster than those without experience can. Professionals already know how to address business losses and deductions. They also keep up with tax laws and changes, letting you off the hook from keeping up with it all.
And remember, even if you choose to use a professional this time does not mean you can never file them yourself. You can always take a tax season or two to learn what you need to know, and then do them yourself later when you are more comfortable.
Conclusion
Claiming business losses on personal taxes does not have to be as intimidating as it sounds. With the right guidance, software, or professional on your side, you can take on anything.
Whether you choose to file your own taxes or use a tax preparation service, don’t forget to check out Taxry. You’ll find plenty of educational items on tax-related topics as well as lists of recommended tax firms, pricing, reviews, and much more. Let us help make your tax season more painless than ever.