top of page
  • Instagram
  • LinkedIn
  • Facebook
Search

What Small Business Owners Need to Know About Business Loss Deductions

If you're a small business owner or investor facing large losses this year, don’t assume you can automatically deduct them from your personal income. The IRS has rules in place that can limit your ability to claim those losses — and understanding them could help you avoid an unexpected tax bill.


Here’s a breakdown of how these rules work and what they mean for your tax planning process.


The Disallowance Rule: What It Is and Why It Matters

If your business or rental activity shows a tax loss, two potential limitations may apply:


1. Passive Activity Loss (PAL) Rules

  • If you’re not actively involved in the business or if it’s a rental activity, you may be subject to PAL rules.

  • Under these rules, you can only deduct passive losses up to the amount of your passive income.

  • However, losses you can’t deduct now can be carried forward and claimed when you sell the related property or business.


2. Excess Business Loss (EBL) Limitation

Even if your losses clear the PAL rules, there’s another hurdle: you may not be able to deduct all of your business losses in the year incurred.

  • For 2025, you can only deduct up to $313,000 in business losses ($626,000 for married couples filing jointly).

  • Any loss beyond that becomes an Excess Business Loss (EBL).

  • The EBL is not lost, but it must be carried forward to future years as a Net Operating Loss (NOL).


Carrying Forward Net Operating Losses (NOLs)

Once a loss becomes an NOL, here’s how it works:

  • It can only be used to offset up to 80% of taxable income in future years.

  • It generally cannot be carried back to prior years.

  • However, it can be carried forward indefinitely until it’s fully used.


This means your tax relief from big business losses may be delayed, often by a year or more. Let’s look at some examples.


Example 1: Loss Limited by the Disallowance Rule

David, a single taxpayer, loses $400,000 this year from his AI startup.

  • He has $500,000 in income from salary, investments, etc.

  • He can deduct $313,000 of the loss on this year’s tax returns.

  • The remaining $186,000 becomes an NOL, carried forward to 2026.


If David’s loss had been $313,000 or less, he could have deducted it all this year.


Example 2: No Limitation Applies

Nora and Ned, a married couple filing jointly. Nora loses $350,000 from rental real estate, and Ned loses $150,000 from his startup.

  • They have $600,000 in income from other sources.

  • Their total business losses: $500,000, which is under the $626,000 threshold.


They can deduct the full $500,000 this year with no carryover.


What About Partnerships and S Corporations?

If you own a partnership, LLC, or S corporation, the EBL limitation is applied at the individual level.

  • Each owner reports their share of income/loss on their personal return.

  • The disallowance rule applies based on your individual threshold for the year.


Bottom Line: Plan Ahead for Losses

Large business losses can create valuable tax deductions — but only if you understand the limitations and timing. If you think you may be affected by the excess business loss rules or PAL restrictions, now is the time to strategize.


Need help navigating business loss rules? We’re here to guide you through the rules and help you plan effectively. Contact your VAAS Pro Tax Consultant to discuss your tax strategy and how to get the most out of your expected losses.

bottom of page