What happens if you just started your business and your expenses are greater than your losses? In that case, you’ll have a business loss to report. Note that this only applies for a pass-through tax vehicle – i.e. a sole proprietorship, your own LLC, your own S-Corp (it’s more complicated for an S-Corp, which we’ll discuss below), or your portion of a partnership. This would not apply to a C-Corp (a C-Corp business can have a loss, but the C-Corp is an independent tax paying entity from you, so you wouldn’t necessarily receive a benefit on your personal taxes that year).
There are some expenses that cannot be deducted to generate a loss, for example depreciation. You’re only able to deduct a depreciation expense up to the amount that gets your profit to $0.
If you subtract your business expenses from your income, and the number is negative, you have a Net Operating Loss (“NOL”). Note that this has to be solely from your business – so make sure you have not taken the Standard Deduction or Itemized Deduction yet. You’ll also have to add-back any net capital losses (capital losses in excess of capital gains) and any non-business deductions that exceed your non-business income. The goal here is to get to the loss solely based on your business activity.
You can apply the NOL to the current tax year or future tax years. You’re limited to claiming no more than 80% of your taxable income as an NOL (so if you have $100 in income, you can only apply $80 of NOL that year), so you may have to take it over multiple years. If you carry forward a NOL to use in a future year, list the NOL deduction on the “Other Income” line of Schedule 1. You must also attach a statement that shows the important facts about your NOL, including a calculation showing how you computed the NOL deduction.
For an S-corp, the calculation is a little more complicated. The IRS tried to prevent people from deducting losses from investment vehicles to lower their income taxes, so there is a passive loss test that requires you to be actively engaged in the business (which presumably you are). Additionally, the stock basis and debt basis rules say that you can only take losses up to your capital basis (the amount of capital you contributed to form the company). Losses in excess of your capital basis are suspended and carried forward indefinitely until the basis limitations allow them to be deducted. Presumably, you set up an S-corp because your business was doing well, so hopefully this doesn’t come into play. However, if you need more information you can find details on tax loss implications for S-corps here.
Additionally, the IRS provides a lot more general details on NOLs here.