Q: My wife tried a small business and it failed after a short time. We lost about $30,000 on it. What can we write off?
A: After your business fails, the IRS allows you to write off all “reasonable” and “necessary” expenses incurred in the attempt to make it successful.
Those are very broad terms, but they encompass just about anything you spent in a business setting to try to earn money, says tax attorney Brian Whitlock of Blackman Kallick in Chicago.
That includes everything from rent and office supplies to advertising costs and mileage for business travel, says Michael Beauchemin of the Charlotte, N.C.-based Carolina Accounting and Tax Service.
Your business losses will give you a federal tax deduction you can use against your remaining income. Unlike tax credits, deductions don’t reduce your tax bill on a dollar-for-dollar basis - you won’t be able to recoup the entire $30,000 you sank into the business. But deductions do reduce your tax bill (exactly how much they save you depends on what tax bracket you fall into) and take the edge off some of the pain of a failed venture.
Where and when you take the deductions will depend on how the business was organized and operated. More detail is provided in IRS Publication 334: “Tax Guide for Small Business.”
If the business was operated as a sole proprietorship, your losses can be claimed on Schedule C of IRS Form 1040. Any expenses in excess of revenue you earned will be deductible without limitation, Whitlock says.
If the business was incorporated, your loss will be the difference between the cash and assets you invested in the business and the value of what you received when you liquidated the company.
Whether you were incorporated or not, your losses can be carried back and forward to reduce your tax liability in previous or subsequent years, says Beauchemin. The rules apply differently depending on your situation. For example, certain small businesses can carry back these losses for several years and forward for up to 20 years.
Remember also, says Whitlock, that if the IRS believes you did not make a legitimate attempt to make your business profitable, it can argue you were engaging in a hobby rather than running a business. Hobby losses are not deductible.
In your case, the experts highly recommend consulting with a CPA or tax attorney for help preparing your taxes. What you’ll spend on fees will likely be offset by the tax advantages an experienced accountant can help you exploit.
By Lenora Chu, CNNMoney.com contributing writer