What Happens to QBI Loss Carryover When a Business Closes?

When a business closes its doors, the fate of its Qualified Business Income (QBI) loss carryover becomes a crucial question for the owners. The short answer is this: the QBI loss carryover doesn’t simply vanish. It remains with the individual taxpayer (the owner or partner) who originally generated the loss and can be used to offset QBI in future tax years, even if the business that created the loss is no longer operating.

Understanding QBI Loss Carryover

Before delving deeper into the specifics of business closure, let’s establish a solid understanding of QBI loss carryovers in general. The Section 199A deduction, often called the QBI deduction, was introduced by the Tax Cuts and Jobs Act (TCJA) of 2017. It allows eligible self-employed individuals, partners, and S corporation shareholders to deduct up to 20% of their qualified business income. However, this deduction is subject to various limitations based on taxable income and the type of business.

When your QBI is negative, meaning your deductions exceed your gross income from the business, you have a QBI loss. This loss isn’t simply ignored. Instead, it is carried forward to future tax years to offset QBI in those years. This is the QBI loss carryover.

The key principle here is that the QBI loss is associated with the individual taxpayer, not necessarily the specific business that generated it.

The Impact of Business Closure

The fact that the QBI loss is tied to the individual, not the business, is the crucial point that dictates what happens upon business closure. When a business shuts down, the following is true:

• The QBI loss carryover remains with the individual taxpayer. The loss does not disappear.
• The individual can use the carryover to offset QBI from any other business they own or operate in the future. It’s not limited to the same type of business that generated the loss.
• The loss can be carried forward indefinitely until fully utilized. There’s no expiration date on a QBI loss carryover.
• The loss will reduce the QBI deduction available in the carryover year. This directly impacts the amount of income that can be sheltered from taxation.

Practical Implications

Let’s illustrate this with an example. Imagine Jane owned a bakery that incurred a QBI loss of $50,000 in 2023. Jane decided to close the bakery at the end of 2023. In 2024, Jane starts a consulting business that generates $80,000 in QBI. Because of the $50,000 QBI loss carryover from the bakery, Jane can offset $50,000 of the consulting business’s QBI. The result is that Jane will only calculate her QBI deduction based on $30,000 of QBI instead of $80,000.

Documentation is Key

It’s paramount to maintain accurate and thorough records of the QBI loss, the business that generated it, and the years in which it is carried forward. This documentation will be essential when claiming the deduction in future tax years. This includes tax returns, financial statements, and any supporting documentation that verifies the QBI loss calculation.

Common Scenarios and Considerations

While the basic principle is straightforward, several nuances and specific scenarios can arise when a business closes with a QBI loss carryover.

Partnerships

In the case of a partnership, the QBI loss is allocated to the individual partners based on their distributive share. When the partnership dissolves, each partner retains their share of the QBI loss carryover and can use it to offset their QBI from other sources.

S Corporations

Similar to partnerships, QBI from an S corporation flows through to the shareholders. A QBI loss incurred by the S corporation is passed through to the shareholders proportionally to their shareholdings. Upon dissolution, the individual shareholders retain their respective shares of the QBI loss carryover.

Sale of a Business

If the business is sold rather than simply closed, the treatment of the QBI loss carryover depends on the structure of the sale. Generally, the QBI loss carryover remains with the seller (the original business owner). The buyer cannot inherit or utilize the seller’s QBI loss carryover.

Frequently Asked Questions (FAQs)

Here are some frequently asked questions about QBI loss carryover when a business closes, designed to provide comprehensive guidance on this complex topic:

1. Can I deduct the QBI loss carryover against ordinary income if I don’t have any QBI in the carryover year?

No, the QBI loss carryover can only be used to offset positive QBI in future tax years. It cannot be deducted against ordinary income like wages, interest, or dividends. It specifically reduces the amount of your QBI from other businesses.

2. What happens to the QBI loss carryover if I pass away?

Unfortunately, the QBI loss carryover is not transferable to your heirs. Upon your death, the QBI loss carryover is lost and cannot be used by your estate or beneficiaries.

3. How do I calculate the QBI loss carryover?

The calculation is done on Form 8995 or Form 8995-A, which you’ll file with your tax return. These forms guide you through determining your QBI, any applicable W-2 wages or unadjusted basis immediately after acquisition (UBIA) of qualified property, and ultimately, the QBI loss carryover amount.

4. If I have multiple businesses, can I choose which business’s QBI to offset with the loss carryover?

Yes, if you have multiple businesses generating QBI, you can generally allocate the QBI loss carryover to the businesses that provide the most tax benefit. However, it is important to carefully document your allocation decisions and ensure they are reasonable and consistent.

5. Does the QBI loss carryover affect my self-employment tax?

No, the QBI loss carryover does not directly affect your self-employment tax. Self-employment tax is calculated based on your net earnings from self-employment, which is determined before considering the QBI deduction or any QBI loss carryovers.

6. Can I amend prior-year tax returns to claim a QBI loss carryover if I missed it initially?

Yes, you can amend prior-year tax returns using Form 1040-X to claim a QBI loss carryover if you inadvertently missed it. Make sure to include all necessary documentation to support your claim. There is typically a statute of limitations for amending tax returns, generally three years from the date you filed the original return or two years from the date you paid the tax, whichever is later.

7. How does a change in marital status (marriage or divorce) affect the QBI loss carryover?

Marriage itself doesn’t directly impact a QBI loss carryover you had before the marriage. However, during the marriage, you can use the carryover to offset QBI from businesses either you or your spouse operate.

In the event of a divorce, the QBI loss carryover remains with the individual who originally incurred the loss. Divorce decrees typically don’t transfer QBI losses.

8. What if my QBI loss exceeds my taxable income in the carryover year?

The QBI loss carryover can only offset your QBI. It doesn’t offset other types of income, nor does it create or increase a net operating loss (NOL). Any unused QBI loss is carried forward to the next year.

9. Are there any limitations on the amount of QBI loss I can carry forward in a single year?

No, there’s no annual limitation on the amount of QBI loss you can carry forward. You can carry forward the entire loss until it is fully utilized, subject to the availability of QBI in future years.

10. What kind of documentation should I keep to support my QBI loss carryover?

Keep comprehensive records, including:

• Tax returns (Form 1040, Schedule C, Schedule E, etc.) for the years the loss was generated and the years it is carried forward.
• Form 8995 or 8995-A showing the QBI loss calculation.
• Financial statements (profit and loss statements, balance sheets) for the business that generated the loss.
• Any supporting documentation used to calculate QBI, such as invoices, receipts, and wage records.

11. Can I use a QBI loss carryover from a rental property to offset QBI from a different business, like a consulting service?

Yes, you absolutely can. The QBI loss carryover can be used to offset QBI from any qualified business, regardless of the type of business that generated the loss. The rules are the same whether your QBI comes from a sole proprietorship, partnership, S corporation, or even a rental property.

12. How does the sale of assets affect QBI loss carryover after a business closes?

The sale of assets after a business closes does not affect the QBI loss carryover itself. If assets are sold at a gain, that gain is separate from the QBI rules. If you have a capital gain from the asset sale, that will impact your overall tax liability, but it won’t impact the QBI loss carryover. The QBI loss carryover remains available to offset QBI from other activities in future years.