Deducting Losses Against Personal Income: Another Reason LLCs can be the Best Option for Small Businesses

A recent tax court decision demonstrates why Limited Liability Companies (LLCs) are a great option for small businesses, as any losses in the new business may be deducted against other income.

The tax court case involved the Hegartys, a couple who worked full-time and decided to start a business on the side, chartering a fishing boat. Like most new businesses, they decided to organize their business as a Limited Liability Company (LLC), which provides the limited liability benefits of a corporation with the tax benefits and flexibility of a partnership. They wanted to characterize their losses from the fishing boat business as active losses, so that any money lost in the business could be deducted from their salaries and other income.

IRS rules state that you must participate in a business for more than five hundred hours per year (little more than nine hours per week), so that losses from that business are considered deductible. The recent tax court decision reaffirms that, generally, those who have organized their business as a Limited Liability Company (LLC) can use a 100-hour test to characterize their business losses as deductible, active losses. So, if you do at least two hours of work per week for your LLC, you can safely deduct losses from that business from your income tax return.

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