A taxpayer operating a business on a Schedule C will normally be deemed to be materially participating in the business.This designation is made on Line G of Schedule C and this question can be found in the tax program on the Schedule C – Edit Menu > Answer Schedule C Questions. The default answer for this designation in the tax program is set to indicate that the taxpayer materially participated in the business.
Material participation is defined as being involved in a business activity in a ‘regular, continuous, and substantial’ manner. The IRS has developed a detailed test that would indicate if a taxpayer is materially participating in their business activity which is primarily based on the number of hours dedicated to the business by the business owner. For more information on the material participation test see Publication 925 – Passive Activity & At-Risk Rules.
In the unusual situation when a taxpayer does not materially participate in a business activity that is being reported on their Schedule C, the ability to deduct a loss will be subject to the passive activity loss limitation rules. Under these loss limitation rules, passive losses can only be used to offset passive income. To the extent the loss from an activity where the taxpayer does not materially participate is used to offset passive income from another activity that the taxpayer has, the loss is allowed. To the extent that a loss is not allowed it becomes a suspended loss which cannot be taken by the taxpayer in the current year. Instead this unallowed loss is suspended until the taxpayer has passive income in the future.
Entering a prior year unallowed loss on a Schedule C in Keystone Tax Solutions Pro
From the Main Menu of the Tax Return (Form 1040) select:
- Income Menu
- Business Income/Loss (Sch C, C-EZ, 1099MISC)
- Select ‘New’ or double-click the entry you wish to ‘Edit’. Select ‘Pull’ if you prepared the return using the software in the previous year and wish to pull the data forward.
- Select Schedule C or Schedule C-EZ
- Select either Taxpayer or Spouse
- Input the Business Code
- Input the Schedule C Data
- Select Exit Menu until you reach Schedule C – Edit Menu
- Select Prior Year Unallowed Loss
- Enter the unallowed loss from the previous year Form 8582 for this business activity.
NOTE: This is a guide on entering an Unallowed Prior Year Loss from a Schedule C into the Keystone Tax Solutions Pro program. This is not intended as tax advice.
Additional Resources: