How Does A Company’s Losses Affect the Individual’s Tax Return?

By Rebecca A. Casarez, CPA
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So, if the K-1 has a loss from the company, can YOU deduct those losses on your personal tax return? The answer is not an immediate “yes” or “no”.

 

So what is a Schedule K-1?

 

A Schedule K-1 is an IRS form that is produced when a Partnership or S-Corporation Tax Return is filed.

Each Equity Owner (Partner or Shareholder) receives a personalized K-1 that reflects their’ portion of the company’s current year Profits (Losses) as well as any non-deductible, owner responsible expenses incurred by the company (such as Charitable Donations or Distributions).

The K-1 is then passed through to the respective Owner’s (Partner’s or Shareholder’s) and is reported on the individual’s income tax return (1040, Schedule E).

 

Losses are only deductible if (all three must be present):

ONE: The reported loss on the Individual Owner’s K-1 is less than the Individual Owner’s tax basis FOR THAT YEAR.

Refer to above explanation on how the Tax Basis fluctuates each year.

TWO: The basis is considered “at risk”: You’re at risk in any activity for the:

  1. Money and adjusted basis of property you contribute to the activity

or

  1. Any amounts borrowed IF:
    • You’re personally liable for repayment, or
    • You pledge property (other than property used in the activity) as security for the loan

THREE: The losses are not passive. In other words, the owner must be actively participating in business operations. (IRS Pub 925 (rev 2016) emphasis added).

All three conditions above must be met for the loss rules to be applied.

 

Bottom line is, both you and your CPA, or Tax Accountant, needs to know your basis because:

  1. Your tax basis will determine (to an extent, as explained above) how much of the business’ losses are deductible.  

    If you don’t know how much basis you have in the business, you won’t know how much you are able to deduct.
  2. Your basis will determine the amount of gain or loss on sale of the business, partner share, or stock.
  1. Your annual Schedule K-1 often looks incorrect or inconsistent due to the changes made annually.

    If you have changed accountants over time, they may not have been calculating your basis correctly and applying the correct balances.

Your CPA or Tax Accountant should be involved throughout your ownership of every investment company to properly advice you on tax and accounting changes and how they will impact you on an individual level.

 

Sources:

Corporations, Partnerships, Estates and Trusts 2017 Edition. Authors: Hoffman, William; Raabe, WIlliam; Maloney, David; Young, James. Publisher: South-Western Cengage Pages: 14-4 to 14-8.

IRS.gov (2016). Publication 925. Retrieved July 24, 2017 from: https://www.irs.gov/publications/p925/ar02.html#en_US_2016_publink1000104595

 

Disclaimer:
This publication is designed to provide information of federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.
This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.
This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used and cannot be used by a taxpayer or tax return preparer, for the purpose of avoiding penalties that may be imposed.

Tags: Taxes

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