My small business lost money in 2025—can I use that loss to reduce taxes in future years?

If your small business, reported on Schedule C, incurs a net loss for the 2025 tax year, you generally can use that loss to offset other income, such as your W-2 wages, on your current year's tax return. However, the ability to fully utilize the loss immediately or carry it forward depends on several factors, primarily the nature of the business activity and whether you meet the IRS definition of being 'active' in the business.

### Active Business Losses (Material Participation)

If your business is classified as an active trade or business—meaning you materially participate in its operations (often defined by meeting specific hours thresholds)—the loss is generally treated as an ordinary loss and can be used immediately to offset your W-2 income, thereby lowering your overall taxable income for 2025. This is the most favorable outcome.

However, this immediate deduction can be limited by two major rules:

• Hobby Loss Rules (Section 183): If the IRS determines your business lacks a profit motive and is merely a hobby, you cannot deduct losses. For 2025, the IRS presumes a profit motive if the activity shows a profit in at least three out of five consecutive tax years (two out of seven for horse activities). If challenged, you must prove you are operating the activity with the intent to make a profit.
• Excess Business Loss Limitation: For 2025, the Tax Cuts and Jobs Act (TCJA) limits the amount of net business losses a non-corporate taxpayer can deduct against non-business income (like W-2 wages). Any loss exceeding the inflation-adjusted threshold for 2025 is disallowed in the current year and must be carried forward as a Net Operating Loss (NOL).

### Passive Activity Losses (PALs)

If your business activity does not rise to the level of material participation, it is classified as a passive activity. Losses from passive activities are generally only deductible against passive income earned in the current year or future years. Passive losses cannot typically offset W-2 wages or portfolio income (like interest or dividends) in the year they occur.

If you have a passive business loss, it is suspended and carried forward indefinitely until you either generate passive income or dispose of the entire interest in the activity in a fully taxable transaction.

### Carrying Losses Forward (Net Operating Loss - NOL)

Losses that are disallowed in 2025 due to the Excess Business Loss Limitation are carried forward to 2026 and subsequent years as an NOL. Under current rules (post-TCJA), NOLs carried forward are generally limited to offsetting only 80% of taxable income in the carryforward year. The NOL can generally be carried forward indefinitely, but it cannot be carried back.

In summary for 2025: Check if you materially participate. If yes, your loss first reduces W-2 income, but the amount exceeding the annual Excess Business Loss threshold must be carried forward as an NOL to offset 80% of future income.