Business & Finance

How S Corp Losses Affect Your Taxes

A common concern among small business owners is how S Corp losses affect their taxes. Fortunately, there are ways to reduce or eliminate the tax impact of an S Corp loss on your income statement.

One such way is by converting shareholder loans into additional paid-in capital. This adds to your shareholder basis and makes it easier for you to deduct losses in future years.


Losses are Passed Through to Shareholders

Will s corp business loss impact personal tax? S corporations are taxed as pass-through entities, meaning income, losses, deductions, and credits flow to shareholders. Shareholders report these items on their income tax returns.

The IRS describes S corporations as “corporations that elect to be taxed as a pass-through entity.” In this scenario, corporation profits are not subject to corporate income taxes. Instead, they are passed through to shareholders in proportion to their ownership interests.

However, this doesn’t mean that owners of S corps don’t have to pay much attention to how they distribute their business income. The IRS has a few requirements that shareholders must meet, especially regarding dividend payments to employees or shareholders.

Those rules are designed to ensure that business owners aren’t using S corps to avoid paying their fair share of federal and state taxes. If you’re considering setting up an S corp, talk to a small business lawyer for advice.

Shareholders Can Deduct Losses

Shareholders can deduct losses they are at risk for based on the amount of cash they have contributed to the business. For example, if Bob and John each have an S corporation with a net loss of $20,000, but each has only contributed $20,000 to the company, they each have an at-risk basis for $20,000.

The at-risk basis of shareholders in S corporations is similar to that of partnership partners. However, there are some differences.

For example, the shareholder’s tax basis in their S corporation stock may be increased or decreased based on income items and other pass-through amounts from the corporation. Losses, deductions, non-dividend distributions, and certain corporate distributions also reduce it.

There are some limitations on the number of losses a shareholder can deduct, and the IRS has several rules to limit shareholder losses. For instance, married taxpayers filing jointly can only deduct up to $250,000 of total business losses under the Tax Cuts and Jobs Act.

Shareholders Can Deduct Bad Debt

The primary reason S corps are so popular with small business owners is that their profits and losses are not subject to corporate tax. Instead, they are passed through to shareholders who report their income on their tax returns.

S corp owners also benefit from limited liability protection, protecting their personal assets from losses and debt claims against the corporation. However, not all states recognize S corps, so it’s important to discuss the taxes that may apply in the state where the corporation does business.

The IRS is always skeptical when an individual taxpayer claims deductions for bad debt losses. These losses often come from some wrong deal, such as making a contribution to a company’s capital that turned out to be a loser or lending money to a friend without a written contract.

Shareholders Can Deduct Capital Injections

When shareholders borrow money from the corporation, they can deduct their investment as additional paid-in capital. This is a much better tax treatment than calling it a loan to the business, which could result in taxable income to the owner.

Shareholders also may deduct other costs of owning the corporation, such as interest expenses or a charitable contribution. However, some of these items are subject to limitations.

For example, the basic rules apply to S corporation shareholders, and a shareholder cannot claim losses and deductions over their stock and debt basis.

If a shareholder can reduce their basis, unused losses are suspended and carried forward until the basis limit is reached. Once it is reached, the shareholder must restore their debt basis before the losses can be used to decrease the stock basis.