IRS Schedule K-1 is the schedule that partnerships, S corporations and limited liability companies use to report business income and losses. If, for example, you and two partners own the company equally, your individual K-1 forms will assign each of you one-third of the profits. If the company's into the red, you get a third of the net losses instead.
If your K-1 shows a net loss, you report it on the appropriate tax schedule, for example Schedule E for a partnership. Then you write in the loss on your Form 1040 and deduct it from any other taxable income. As long as you end up in the black overall, you can deduct all your losses. If your net taxable income ends up in the red, however, you don't get to claim "negative income." Instead, if you have a net operating loss, you can deduct it from past or future taxable income.
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Net Operating Loss
If your deductions are greater than your income, you need to do further calculations to determine whether you have a net operating loss. These calculations are described in IRS Publication 536, but the basic idea is that you must add certain deductions back in, to see if you qualify. For example, your exemptions for yourself, your spouse and your dependents get added back in. If you still have red ink when you finish, you have a genuine NOL.
If you have an NOL, you can carry it back, or carry it forward. To carry back, you deduct the NOL from your income two years ago, using a formula in IRS Publication 536. You file a Form 1045 or a 1040X to claim a new tax refund for that year. If you still have some losses left, you then deduct it from last year's income. After that, you start taking it off future years. You can also choose to skip the carry back and only take the NOL off the years ahead.
Unlike business losses, putting personal money in a partnership or LLC doesn't give you a write-off. It's an investment, just like buying stocks, so even though the money's tied up, you haven't lost anything. If you decide to leave the firm and withdraw your assets, you may get a deduction if it turns out your investment has lost value. To figure a loss, you have to take into account the value of your original investment, the profits you've taken out of the firm over the years and the total assets you're leaving with.