A limited liability company (LLC) doesn’t always make a profit, especially if it’s a new business. Luckily, a lack of business income isn’t always a bad thing — you can probably deduct any net operating losses (NOL) from your taxable income.
In this article, we explain how LLCs can deduct their losses, what net operating loss is, and how this tax law can help small business owners lower their taxable income.
Can I Offset My LLC Losses Against My Personal Taxes?
As a business owner and taxpayer, you may know that you can deduct business expenses. But you may not be aware that you may also be able to deduct business losses. These deductions reduce your taxable income, likely lowering the amount you pay out of pocket for costs like self-employment taxes.
And most LLCs can report their business losses against their personal income. You will be able to do this if you operate as a:
The one LLC entity that can’t include LLC losses on their individual tax returns is one that operates as a C corporation.
How Does an LLC Deduct Business Losses and Net Operating Losses?
It’s not necessarily a bad thing to operate at a loss in the beginning. In fact, if you experience a net operating loss, it’s actually considered a business asset on your balance sheet because you can use it to receive a tax benefit on another tax year. We explain more about using this process, called carryback or carryforward, for your net operating loss below.
In the meantime, if you need to increase cash flow for your LLC, small business financing is an essential tool that many business owners like you rely on. Business credit cards and small business loans can be fantastic options, and you can use Nav to see the options you’re most likely to qualify for. And building business credit is the first step on your financing journey, so learn how to build business credit using this guide from Nav’s experts.
Keep in mind: Tax deductions don’t lessen your tax burden dollar-for-dollar like tax credits do. Instead, you’ll be taxed on less of your income after you take out LLC deductions.
Figuring Out a Net Operating Loss for LLCs
You have a net operating loss when your business deductions equal more than your business income. For example, if you deduct $50,000 in business expenses for your LLC but only made $30,000 in the current year, you have a net operating loss of $20,000. The IRS allows businesses to report a net operating loss as a form of tax relief. The law is especially helpful for new businesses paying for LLC startup costs since many don’t make money in the beginning.
To calculate whether or not your business has an NOL, follow this formula:
Adjusted gross income – business deductions = net operating loss
Subtract your business deductions — but not personal exemptions — from your adjusted gross income on your tax return. If you come up with a negative number, you have a net operating loss.
Deducting a Net Operating Loss for LLCs
As an LLC, you can use a net operating loss carryforward to provide relief when you pay taxes. You used to be able to carryback your NOL but can’t anymore.
- Carryforward: You can carry your NOL forward to your next years’ taxes (indefinitely) to apply against any taxable income your business generated. This would lower your business’s tax liability. You can’t skip years and must carry it forward to the next tax year — but if there is any left over, that can be carried forward to the next year.
- Carryback: Prior to the Tax Cuts and Jobs Act of 2017, most businesses could apply their NOL to their five previous years’ taxes. However, this is no longer allowed for most businesses.
The ability to use a carryforward depends on your business entity, however — only pass-through entities can claim an NOL; in other words, business owners that pay their business taxes on their personal tax returns, like LLC members. Sole proprietorships and C corporations can also deduct an NOL, but partnerships and S corporations cannot. Always consult a tax professional who understands your tax situation and the tax laws in your location before filing your Schedule C.
Annual Dollar Limit on Loss Deductions for LLCs
There is a loss limitation threshold to how much you can deduct. In 2021, the threshold for excess business losses was $262,000 for single filers and $524,000 for joint filers.
Additionally, for tax years 2021 and beyond, federal deductions are limited to 80% of your taxable income (without deducting NOL). The rules are slightly different for previous years, but the current tax year is relevant to most small businesses.
How Many Years Can You Claim a Loss With an LLC?
As an LLC, you want to be careful to try not to report losses for more than two years. Otherwise, the IRS may decide to classify your business as a hobby rather than an actual business. If this happens, you can’t deduct your business expenses for tax purposes.