Claiming A Net Operating Loss For A Sole Proprietor

An operating loss on self-employment income is usually offset by income gains in other areas. However, the loss is sometimes greater than all other sources of income combined. Self-employed individuals with a net operating loss can sometimes use the loss to offset income from other years and receive refunds or tax reductions.

A loss on self-employment activity is reported as a negative figure on Form 1040. Other income sources are likely to be entered as positive figures on Form 1040. Because a loss typically offsets gains, the result is usually a reduction in overall taxable income.

There is a designated line on Form 1040 for entering either your standard deduction amount or your itemized deductions entry. The very next line is line 41, which contains a simple instruction to derive the entry amount. If the line 41 entry is negative, you might have a net operating loss. If so, another form is necessary to determine if you have a loss that may be used to offset income from other years.

Request refunds from prior years

The purpose of IRS Form 1045 is to recalculate certain aspects of your tax return and arrive at a specific net operating loss. A net operating loss can be carried back for two years, possibly providing a relatively quick refund of taxes paid for those years.

Form 1045 is not filed with Form 1040. A caption at the top of Form 1045 clearly instructs to mail the form in a separate envelope. Form 1045 is only a claim for the refund of income tax amounts paid in prior years. If your net operating loss cannot be fully absorbed by earlier gains, a different technique is used to affect future tax returns.

Reduce future tax

A net operating loss can be carried forward for up to 20 years if necessary. There is a specific line on Form 1040 designated for miscellaneous sources of income. To carry a net operating loss forward to a future tax return, the amount carried to that particular year is entered as a negative figure on the line for other income. There is no official form to support the carryforward entry, so you must attach an explanation statement.

Although a net operating loss usually consists of a business loss, you may be able to claim a net operating loss due to a personal casualty or theft. For more information, contact Amos Maney & Payne CPA's LLC or a similar firm.