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By Alison K Plaut
Published on 21 Feb 2024 5 min read
Setting up a business might sound glamorous, but you’ll need to get into the nitty-gritty details of business structure and taxation. A limited liability company (LLC) business structure gives your company both flexibility and protection. The LLC helps shield your personal assets from legal liabilities. Plus, you have the flexibility to choose how you want to be taxed.
Despite its flexibility, how you treat LLC losses depends on how you are taxed. If your company loses money, can LLC losses offset W-2 income?
Understanding LLC Losses
A limited liability company (LLC) provides a way to structure your business so you can limit your exposure. You establish an LLC based on the rules of your state.
LLCs may have one or more members. When an LLC has more than one member, each member shares in the company’s profit or losses, typically based on their percentage of ownership.
An LLC has a taxable loss when its deductible expenses exceed its income. The IRS views LLCs as a sole proprietorship, partnership, or corporation for tax purposes. LLCs can elect to be taxed as a corporation or not. How an LLC reports its taxable activity to the IRS determines how and where its members report their pro-rata share.
Understanding W-2 Income
Your W-2 income is what you earn when you are employed. W-2 employees have federal, Social Security, and Medicare taxes withheld from their earnings.
LLC Losses Offsetting W-2 Income: Is It Possible or Not?
Your ability to offset LLC losses with W-2 income depends on how the IRS views your LLC for tax purposes. A single-member LLC that the IRS views as a sole proprietorship could offset LLC losses against W-2 Income. However, multi-member LLCs or those taxed as S Corporations may be limited to how much and what type of income may be offset by LLC losses.
The Tax Cuts and Jobs Act (TCJA) limits how much business losses you can claim in a year. If you file single, the threshold for excess business loss is $289,000 ($578,000 for joint-filers). Amounts over this threshold may be carried to the next year.
How to Report LLC Losses on Your Personal Return?
To determine if you can report LLC losses on your personal return, you consider how the IRS treats your company for tax purposes.
If the LLC Is Solely Owned
The IRS views an LLC with only one owner as a disregarded entity. So, if you are the sole owner of your LLC and did not make the election for corporate tax, you report your income and expenses on Schedule C of your personal tax return.
When your Schedule C shows net income, you pay tax on your earned income. When a Schedule C shows a loss, the LLC losses can offset W2 income.
If the LLC has Multiple Members
An LLC that is not incorporated and has two or more members is deemed a partnership by the IRS. Multiple-member LLCs must file Form 1065: Return for Partnership Income. Each member receives a K-1, which reports their requisite share of income or loss from the partnership.
Members pay federal and self-employment taxes on their share of the partnerships’ earnings. Should the LLC realize a loss for the year, you may deduct losses against other income on your personal return, but only if you have sufficient basis in your LLC ownership interest. You cannot deduct losses exceeding your basis; you may carry it forward to the following year.
So, what does basis mean? In an LLC, your basis represents your total investment. You have a basis in an LLC if you put money into the company or buy an ownership interest. Your basis increases if the LLC earns a profit or you contribute more money. However, your basis decreases when the LLC has losses or distributes cash.
Let’s assume you invested $20,000 in your LLC. If the company experiences a $30,000 loss in its first year, you may only deduct losses up to your basis, or $20,000.
If the LLC is a C Corporation
An LLC may elect to be taxed as a C Corporation. No income or expense flows through to the member’s personal tax returns when organized as a C Corporation. Instead, the LLC reports all activity on Form 1120: U.S. Corporation Income Tax Return.
You remit taxes due at the corporate level. Since no income flows through directly to its members, they cannot offset personal income against LLC losses.
If the LLC is an S Corporation
When an LLC elects to pay tax as an S Corporation, it must also report its income and expense activity at the corporate level on Form 1120S: U.S. Income Tax Return for an S Corporation. However, each member receives a Schedule K-1, which reports their pro-rata share of the LLC’s net income or loss. Each member reports K-1 earnings or loss on Schedule E of their personal tax return.
Like a multiple-member LLC, your ability to deduct losses depends on your personal investment. For an S Corporation, however, you must materially participate in the company’s operations to deduct your losses against other income.
Your involvement in the S Corporation is passive when you cannot meet the requirements for material participation. You may only deduct any loss incurred against other passive income and rental activities.
Keep Tabs on your LLCs with doola Books
Staying on top of your finances may seem like a daunting task. Bookkeeping can easily fall to the bottom of your list of things to do when you are busy. Yet when your books are current, you know where your money goes and how much you have in your bank account. You have a better handle on your finances and can make better business decisions. Also, accurate records are critical to support your LLC losses on your tax return.
doola Books is an effortless way to keep your financial records current. Link your accounts to the doola platform, and books are automatically updated. Clean and simple reports make it easy to see where your company’s finances are. When bookkeeping seems like a chore you don’t have time for, doola Books may be your solution.
FAQs
Are LLC losses considered passive losses?
In some cases, yes. When taxed as an S Corporation, you may have a passive loss if you don’t materially participate in the LLC’s operations. Moreover, if you do not materially participate in a single-member or multiple-member LLC, your loss is considered passive. With a few exceptions, rental activities represent passive income even if you materially participate in the LLC’s operations.
Can LLC losses offset other types of income?
Losses in a single-member LLC taxed as a corporation can offset other types of income, including W-2 earnings. If you have a loss in a multiple-member LLC, you might be able to offset other income to the extent of your investment. Losses incurred by an LLC taxed as an S Corporation may offset income based on your investment and material participation in its operations. You can only deduct any allowable losses against other passive income.
Can LLC losses be carried forward to future years?
Yes, LLC losses flow to your personal return and may carry forward to future years. Net operating losses carry forward indefinitely but are limited to 80% of the taxable income in the year you claim them.
Can LLC losses be carried back to previous years?
No, you may not carry LLC losses back to offset prior years’ income.
Can LLC losses be claimed by all LLC owners?
Whether or not an LLC owner can claim LLC losses depends on how the IRS views the LLC for tax purposes. The owner of a single-member LLC may claim losses on their personal tax return. However, an owner of an LLC taxed as a partnership or S Corporation may only claim losses to the extent of their investment. When taxed as a C Corporation, LLC owners may not claim losses on their personal return.
