Claim LLC Losses on Your Individual Income Tax Return

Graph trending downward with US currencyPlanning for business losses is rarely at the top of the todo list for LLC founders. However, recognizing and planning for potential negative revenue will help to keep your business stable. This is why it is so vital to create not just a profit-sharing provision in your operating agreement, but also a loss-sharing provision.

The good news is that a limited liability company enjoys the same tax advantages of sole proprietorships and partnerships — pass-through taxation — while also enjoying the limited liability protection of corporations. An LLC company’s owners can declare the LLC’s losses on their personal individual income tax returns, allowing them to offset other forms of profit or income.

What is pass-through taxation?

Pass-through taxation means that the revenues and losses of the LLC “pass through” to the LLC’s members. Rather than filing a corporate income tax return on company revenue followed by individual tax returns for disbursed profits — often called corporate double taxation — an LLC member files only a single tax return and pays taxes only once. While this is valuable for LLCs that make a profit, it is also beneficial for business owners whose LLCs are losing money.

What to do with LLC business losses

Profit losses in your LLC should be claimed on your individual income tax return. You most likely will have to use IRS Form 1040, as profit or loss from a business must be declared on Schedule C — expenses that are less than $5,000 may be claimed on Schedule C-EZ. Your business losses will offset any income from any source, such as profit disbursements from the LLC, wages paid in a different job, and even investment or independent contractor income.

How much can I claim as a deduction?

The entirety of the LLC’s business losses may be claimed on individual income tax returns, but the proportion of the business loss must be equal to your fair proportion outlined in the LLC’s operating agreement. If you are the sole owner/member, you may deduct the entire loss. If, however, an LLC has more than one owner/member, you must determine each member’s proportion. This proportion is independent of each member’s financial contribution. In other words, the operating agreement may specify that even though Person A invested $1,000,000 and Person B invested $5,000, profits and losses are shared by Person A and Person B equally.

In the absence of any statement in the operating agreement about how losses will be shared, courts will generally assume that the LLC’s members intended to share losses in the same way that they agreed to share profits.

In other words, if you co-own an LLC with two other people and the three of you agree to share profits equally, you may deduct one-third (1/3) of the LLC’s operating losses on your personal income tax return.

It may be a disappointment to face red, negative numbers in your LLC’s balance sheet, but at least these losses will provide you a benefit at tax time. Always remember to recognize business losses on your tax return or you will be losing out on potentially large tax savings.