What this line means
Your share of net loss from partnerships and S corporations in which you materially participate. Because you materially participate, the loss is nonpassive and can offset any type of income — wages, interest, business income, capital gains. However, the loss is still limited by your tax basis in the entity and by at-risk rules. A nonpassive loss passes straight through to reduce your adjusted gross income if it clears those limitations.
Does this apply to you?
- You actively manage a partnership that reported a loss this year
- You work in an S corporation as an employee-shareholder and the company had a net loss
- You materially participate in a business entity that generated startup losses
- You have basis and at-risk amounts sufficient to absorb the entity’s loss
Easy to overlook
S corporation losses are limited to stock basis plus debt basis For S corporations, your deductible loss is limited to your stock basis plus your direct loan basis (money you personally lent to the corporation). Unlike partnerships, S corporation shareholders do not get basis from entity-level debt. A bank loan to the S corporation does not increase your basis. Many S corporation owners expect to deduct losses backed by corporate debt and discover the limitation when the IRS disallows the deduction. 1 IRS Publication 925 — Passive Activity and At-Risk Rules
Nonpassive losses reduce AGI, which affects other deductions and credits A large nonpassive loss reduces your adjusted gross income, which can unlock or increase benefits tied to AGI thresholds — student loan interest deduction, IRA contribution deductibility, education credits, and the child tax credit. The ripple effect of a business loss on the rest of your return is often overlooked. 2 IRS Form 7203 instructions — Basis limitation on S corporation losses
Watch out for this
Claiming a nonpassive loss that exceeds your basis in the entity. If your K-1 shows a $50,000 loss but your basis is only $30,000, you can deduct only $30,000. The remaining $20,000 is suspended at the basis level and carries forward to the next year. Deducting the full $50,000 without checking basis triggers an adjustment when the IRS matches the loss against Form 7203 or your partnership capital account.
Footnotes
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IRS Publication 925, Passive Activity and At-Risk Rules, S Corporation Basis. https://www.irs.gov/pub/irs-pdf/p925.pdf ↩
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IRS Form 7203 Instructions, Stock and Debt Basis. https://www.irs.gov/instructions/i7203 ↩