Understanding Schedule C: Investment Risk And You

The at-risk rules limit your ability to deduct losses from your business activities. With these rules in place, the losses you may deduct on your individual tax return are limited to your investment in the company. The most common scenario that might result in a disallowed loss under the at-risk rules is if you invest borrowed money that you are not personally responsible for repaying, referred to as nonrecourse debt. Taxpayers with a loss on Schedule C must indicate on Line 32 whether they have all of their investment at risk. Most taxpayers answer that all of their investments are at risk—unless they have nonrecourse debt.

The at-risk rule deals with the amount of your investment in a business that you are personally at risk of losing if the business fails. In other words, this rule has nothing to do with whether the business itself is at risk but rather what you, personally, are at risk of losing. The purpose of the at-risk rule is to prevent you from claiming a loss in excess of what you actually stand to lose. Only the amount you are personally at risk of losing counts towards your at-risk basis, which is also called your tax basis.

You can use Form 6198 to calculate your current year losses, the amount at risk, previous at-risk deductions, and the total allowable deduction for the year. You need to file a separate Form 6198 for each business entity, except for S Corporations, which can be combined on one form.

What is the 'at-risk' rule?

The at-risk rule deals with the amount of your investment in a business that you are personally at risk of losing if the business fails. This rule is in place to prevent you from claiming a loss in excess of what you stand to lose. It is important to note that the rule concerns your personal risk, rather than the risk to the business itself.

The at-risk rule is also referred to as a tax shelter law. It limits the amount of allowable deductions that an individual or closely held corporation can claim for tax purposes as a result of engaging in specific activities that can result in financial losses. These activities are referred to as "at-risk activities".

The amount that a taxpayer has at risk is measured annually at the end of the tax year. An investor's at-risk basis is calculated by combining the amount of their investment in the activity with any amount they have borrowed or are liable for with respect to that particular investment.

If you have a business loss and any part of your investment in the business is not at risk, you must complete Form 6198, At-Risk Limitations. This form helps you to calculate your current year losses, the amount at risk, previous at-risk deductions, and the total allowable deduction for the year.

For Schedule C filers, "at risk" means you are using your own money for the business. If all investment is at risk, you should check Box 32a. If some investment is not at risk, you should check Box 32b. A loss may only be deducted up to the amount you personally have at risk. If a loss exceeds your at-risk investment, the excess amount is a suspended loss and may be deducted in a future year indefinitely, until you have sufficient at-risk basis to absorb it.

How do you calculate the amount at risk?

The amount at risk is the amount of your investment in a business that you are personally at risk of losing if the business fails. This is calculated using the basic risk formula: Risk = Probability x Impact.

To calculate the amount at risk, you need to estimate the probability of failure and determine the amount of money you've invested and may lose. Multiply these two numbers to get the amount at risk.

For example, let's say you invest $10,000 in the stock of your S corporation. If the probability of failure is 10%, your amount at risk would be $1,000 (10% x $10,000).

It's important to note that the amount at risk is different from the tax basis, which includes both your investment in the business and any loans you make to the business. In the case of an S corporation, your tax basis would be your stock basis plus your loan basis.

When filing taxes, you need to report any losses on Schedule C. If all investment is at risk, you would check box 32a on Schedule C. If only some investment is at risk, you would check box 32b and attach Form 6198 to your tax return.

What is a non-deductible loss?

A non-deductible loss is a business loss that cannot be deducted from your individual tax return. The at-risk rules limit your ability to deduct losses from your business activities. These rules ensure that business owners don't deduct more than their actual investment in a business.

The at-risk rules apply to losses from an activity carried on as a trade business or from a real estate activity. They also apply if you have investments that are not at risk, such as:

• Amounts that you borrow from a person who you are related to or from a person who has an interest in your business activity.
• Guarantees, stop-loss agreements, or any similar arrangements.
• Nonrecourse loans, such as seller-financed arrangements, unless the loan is a qualified nonrecourse loan.

The at-risk rules limit your ability to deduct losses from your business activities. With these rules in place, the losses you may deduct on your individual tax return are limited to your investment in the company. In other words, you cannot deduct more than the money you’ve invested in your business that you are at risk of losing.

The at-risk rules generally limit the amount of loss (including loss on the disposition of assets) you can claim to the amount you could actually lose in the business. The purpose of the at-risk rule is to prevent you from claiming a loss in excess of what you actually stand to lose. Only the amount you are personally at risk of losing counts towards your at-risk basis, which is also called your tax basis.

Your initial tax basis is in an S corporation and is equal to your investment in the business plus loans you make to the business. For example, if you own an S corporation and invest $10,000 in the stock and also lend the S corporation $5,000, your tax basis would be $15,000 and is the amount you have at risk. The amount you invest in the capital stock is called your stock basis, and the amount you lend the company is called your debt or loan basis.

If you invest in an S corporation or partnership, the amount of a loss incurred by these entities that you may deduct on your individual income tax return is limited to the amount of your investment your at-risk basis.

You can use IRS Form 6198 to help you figure out how much you can claim if your business lost money during the tax year. You must complete a separate Form 6198 for each business or activity subject to at-risk rules.

What is a qualified non-recourse loan?

A qualified non-recourse loan is a type of financing in which the lender's only remedy in the event of the borrower's default is to foreclose on the property pledged as collateral. In other words, the borrower is not personally liable for repaying the loan, and the lender cannot seek a deficiency judgment against the borrower if the collateral value is insufficient to cover the loan balance.

To be considered a qualified non-recourse loan, certain conditions must be met. Firstly, the loan must be borrowed for the activity of holding real property. This includes not only the property itself but also any incidental personal property and services related to making the real property available as living accommodations. Secondly, the loan must be borrowed from a qualified person or entity, such as a bank or a government agency, or guaranteed by a government entity. Thirdly, no person must be personally liable for repayment of the loan, and finally, the loan must not be convertible debt.

The concept of qualified non-recourse financing is particularly relevant for taxpayers when determining their tax liability. In the United States, the Internal Revenue Service (IRS) considers taxpayers to be "at risk" with respect to their share of any qualified non-recourse financing secured by real property used in their business activities. This means that taxpayers can deduct losses on their tax returns up to the amount they are personally at risk of losing. For example, if a taxpayer invests $10,000 in a business and also lends the business $5,000, their tax basis, or the amount they have at risk, is $15,000. If the business incurs a $12,000 loss, the taxpayer can only deduct $10,000 of that loss on their tax return because that is the amount they personally stand to lose.

How do you file Form 6198?

Form 6198, At-Risk Limitations, is used to determine the profit (or loss) from an at-risk activity for the current year, the amount at risk for the current year, and the deductible loss for the current year.

Who needs to file Form 6198?

File Form 6198 if, during the tax year, you, a partnership in which you were a partner, or an S corporation in which you were a shareholder had any amounts not at risk invested in an at-risk activity that incurred a loss.

You must file Form 6198 if you are engaged in an activity included in the following and you have borrowed amounts described in (3) under Amounts Not at Risk:

• Holding, producing, or distributing motion picture films or videotapes.
• Farming, as defined in section 464(e).
• Leasing any section 1245 property, as defined in section 1245(a)(3).
• Certain equipment leasing activities by closely held C corporations are not subject to the at-risk rules.
• Exploring for or exploiting oil and gas resources.
• Exploring for or exploiting geothermal deposits, as defined in section 613(e)(2).
• Any other activity that is not included in (1) through (5) above.

You do not have to file Form 6198 if you are engaged in an activity included in (7) and you only have amounts borrowed before May 4, 2004, that are described in (3) above.

Form 6198 is a four-section worksheet that helps you to:

• Determine losses for the present year.
• Estimate the amount at risk within the business.
• Calculate at-risk deductions from earlier years to apply to the present year.
• Determine the overall allowable deduction you'll be able to take for the present tax year.

When filing your return, Form 6198 must be filed with it if you’ve experienced any losses in income-producing activities considered to be “at-risk” by the IRS. At-risk limitations apply to many business activities.

A separate worksheet must be completed for each entity or activity subject to at-risk rules. Form 6198 Parts II and III are completed based on the information entered in Lines 1 through 24. If the losses from the entity or activity are limited by at-risk rules, a statement behind Form 6198 will detail the loss allowed and disallowed.

Frequently asked questions