Module Overview

Taxpayers can engage in various trade or business activities for profit. Those business income and losses are primarily reported on three IRS schedules: Schedule C (Profit or Loss from Business), Schedule E (Supplemental Income and Loss), and Schedule F (Profit or Loss from Farming). While each schedule serves a distinct purpose, they share some common features.

Net profit or loss calculated on Schedules C, E, and F generally transfers to Schedule 1 of Form 1040 and then into the AGI computation on the taxpayer’s return. Positive net income increases AGI and may create or increase tax liabilities and phaseouts, while net losses reduce AGI to the extent permitted by statutory and regulatory limits. Several rules limit the immediate deductibility of business losses. At‑risk rules (§ 465) limit deductions to a taxpayer’s economic investment, while passive activity loss rules (§ 469) generally permit losses only against passive income; excess business losses for noncorporate taxpayers (§ 461(l)) may be disallowed and treated as net operating loss (NOL) carryforwards under IRC § 172. Income reported on Schedules C, E, and F may qualify for the Section 199A (QBI) deduction when the activity is a trade or business and statutory tests are met. Generally, noncorporate taxpayers can deduct up to 20% of qualified business income, but the deduction is limited by taxable‑income thresholds, specified service trade or business (SSTB) status, W‑2 wages, and the unadjusted basis of qualified property.

Income (loss) Reporting

Schedule C: Profit or Loss from Business

Schedule C is the principal IRS form used by individuals to report profit or loss from a trade or business operated as a sole proprietorship or a single‑member LLC treated as disregarded for tax purposes. The form captures gross receipts, cost of goods sold where applicable, and ordinary and necessary business expenses, such as advertising, supplies, contract labor, business‑use vehicle expenses, depreciation, and eligible home‑office costs, to arrive at net profit or loss.

Common activities reported on Schedule C include independent contracting and freelance work (for example, consultants, software developers, writers, and designers), small business operations (retail, services, and small‑scale production), gig‑economy earnings (ride‑sharing, delivery, and other platform‑based work), and professional practices operated by sole practitioners. Net income from Schedule C flows to Schedule 1 of Form 1040 and generally subjects the taxpayer to self‑employment tax, which is reported on Schedule SE; consequently, taxpayers must account for both income‑tax and self‑employment tax consequences when evaluating business results, including the deduction for one‑half of self‑employment tax as an above‑the‑line adjustment and the need to make estimated quarterly tax payments when appropriate.

See video for Schedule C walkthrough

Schedule E: Supplemental Income and Loss

Schedule E consolidates several types of supplemental income and loss and is the schedule for reporting rental activities, royalties, and the pass‑through of items from entities taxed as partnerships or S corporations. The form captures each activity’s gross receipts and allowable expenses.

Rental real estate and royalty income include amounts received from leasing residential and nonresidential property, short‑term rentals, and royalty payments for the use of intangible and natural resources. For rental activities, taxpayers report both the revenue and the routine operating expenses, such as repairs, maintenance, property taxes, insurance, and depreciation, and they must determine whether the rental activity is passive for purposes of the passive activity loss rules (Internal Revenue Code §469). Royalties arising from patents, copyrights, mineral rights, and similar intangible property are similarly reported on Schedule E when they are not trade or business income reported elsewhere.

Income from pass‑through entities reaches the individual return through Schedule E. Partnerships file Form 1065 and issue Schedule K‑1s that allocate each partner’s distributive share of income, deductions, and credits in accordance with the partnership agreement and the rules of Internal Revenue Code §704; partners are taxed on their distributive share under §§701 and 702 whether or not the partnership distributes cash. S corporations file Form 1120‑S and issue Schedule K‑1s reflecting each shareholder’s share of items passing through under Subchapter S (see IRC §§1361 et seq. and §1366 for pass‑through treatment). Estates and trusts report distributable net income on Form 1041 and provide Schedule K‑1s to beneficiaries, who then report their share on Schedule E. Holders of REMIC interests receive Schedule Q information (Form 1066) and report the REMIC‑related items on Schedule E.

Because Schedule E aggregates passive and nonpassive items from diverse sources, taxpayers must carefully reconcile K‑1 information, apply the passive activity loss rules where appropriate, and consider special allocation and basis rules that affect the timing and deductibility of losses.

See video for Schedule E walkthrough.

Schedule F: Farm Income and Loss

Schedule F is the form taxpayers use to report farm income and expenses and to determine the net profit or loss from agricultural operations. Farmers report receipts from the sale of crops, livestock, and other farm products, along with other farm‑related income such as cooperative distributions, commodity credit payments, crop insurance proceeds, and certain government program payments. The form also captures permitted adjustments to income, including inventory changes, cost of goods sold for farming operations, and returns and allowances.

Certain farm activities raise special tax considerations. For example, sales of livestock raised for draft, breeding, or dairy purposes may be treated differently than sales of livestock held primarily for resale, and growers should be attentive to the tax rules governing inventory valuation and the treatment of growing crops. In addition, farm taxpayers may face unique issues such as timber sales, conservation expenditures, casualty loss allocation, and the interaction of crop insurance proceeds with income and basis.

Qualified Business Income Deduction (§ 199A)

The Qualified Business Income (QBI) Deduction, enacted under the Tax Cuts and Jobs Act (TCJA) of 2017, is a significant tax benefit for owners of pass-through entities, such as sole proprietorships, partnerships, S corporations, and certain limited liability companies (LLCs). Also referred to as the Section 199A deduction, it allows eligible taxpayers to deduct up to 20% of their qualified business income (QBI) from their federal income taxes. This deduction aims to provide tax relief to small business owners, aligning their tax treatment with the reduced corporate tax rates introduced by the TCJA.

QBI is the net income (profit) from a qualified trade or business, calculated as the business’s gross income minus allowable business expenses. A business must be conducted in the U.S. and qualify under Section 199A. Specified Service Trades or Businesses (SSTBs), such as law or accounting, face additional restrictions at higher income levels. When a taxpayer has multiple business activities reported on Schedules C, E, and F, the QBI deduction is calculated by aggregating the QBI from each qualified trade or business, and applying limitations based on taxable income, W-2 wages or UBIA. The QBI deduction is calculated and reported on either Form 8995 (Simplified Computation) or Form 8995A (Regular computation).

See Video for Form 8995 walkthrough

Loss Limitation Rules

Loss limitation rules are primarily designed to prevent taxpayers from unduly using losses from certain activities to offset other, higher-taxed income. Without these limitations, individuals might engage in business primarily for tax benefits rather than genuine economic profit. The primary loss limitation rules include basis limitations, at-risk rules, passive activity loss (PAL) rules, and the excess business loss limitation. It’s important to note that these loss limitations are generally applied in a specific order. Typically, the basis limitations are applied first, followed by the at-risk rules, then the passive activity loss rules, and finally the excess business loss limitation. Tax basis limitation and at-risk limitation are applied at entity/activity level. PALs and excess business loss limitation will be applied at the individual tax return level. A loss must clear each hurdle to be deductible. For example, even if a taxpayer has sufficient basis and is at risk for the amount of the loss, it may still be disallowed if it is considered a passive activity loss and the taxpayer has no passive income to offset it.

Basis Limitations (§ 704(d) for Partnerships, § 1366(d) for S Corporations)

Partners and S corporation shareholders can only deduct losses to the extent of their tax basis in the partnership or S corporation. A partner’s basis generally includes their contributions to the partnership, their share of partnership income, and certain partnership liabilities. An S corporation shareholder’s basis typically includes their contributions to the corporation and direct loans they have made to the corporation. Losses that are disallowed due to insufficient basis can be carried forward indefinitely and deducted in future years when the owner has sufficient basis.

Basis limitations generally do not apply directly to Schedule C or F activities in the same way they do for pass-through entities. For a sole proprietorship (Schedule C) or a farming business (Schedule F), the taxpayer is the business, and their “basis” is essentially their at-risk amount in the business. Therefore, for these direct ownership structures, the at-risk rules effectively cover the concept of basis limitation.

At-Risk Limitations (§ 465)

The at-risk rules further limit the deductibility of losses to the amount the taxpayer has at risk in the activity. The amount at risk generally includes the taxpayer’s cash contributions and the adjusted basis of other property contributed to the activity, as well as certain amounts borrowed for use in the activity for which the taxpayer is personally liable. Nonrecourse debt, for which the taxpayer is not personally liable, generally does not increase the amount at risk. Losses that are disallowed under the at-risk rules can be carried forward indefinitely and deducted in future years when the taxpayer has an increased amount at risk.

Losses from Schedule C, Schedule E, or Schedule F are always subject to the at-risk limitations under IRC Section 465. This means that if the taxpayer has invested less than the amount of the loss (e.g., if they funded the business with nonrecourse debt where they are not personally liable), their deductible loss will be limited to their at-risk amount.

Passive Activity Loss (PAL) Limitations (§ 469)

The primary limitation under IRC Section 469(a) states that losses from passive activities can only be deducted to the extent of income from other passive activities. Losses that are disallowed under the PAL rules are considered “suspended passive losses” and can be carried forward indefinitely. These suspended losses can be deducted in future years when the taxpayer has passive income or when they sell their entire interest in the passive activity. The fundamental purpose of the PAL rules is to limit the ability of taxpayers to use losses from passive activities to offset income from active income or portfolio income.

Under the passive activity loss rules, all income and loss items are sorted into three categories.

• Passive income: Income or loss from activities in which taxpayer does not materially participate (e.g., rental activities, limited partnership interest). Material participation generally means the taxpayer is involved in the operations of the activity on a regular, continuous, and substantial basis.
• Portfolio income: Portfolio income includes Interest, dividends, annuities, royalties, capital gains and losses. The Internal Revenue Code (IRC) doesn’t have a single, direct section explicitly titled “Definition of Portfolio Income.” Instead, portfolio income is defined largely by exclusion. It refers to income specifically excluded from the definition of passive income under the passive activity loss (PAL) rules in IRC Section 469(e)(1)(A).
• Active income: An activity in which the taxpayer does materially participate generates active income. It includes salaries and wages, guaranteed payment for services, business income or loss from activities in which taxpayer materially participates.

The very nature of the activities reported on each schedule dictates the typical application of PAL rules: Schedule E often involves investments or activities designed to be passive or where material participation is absent, while Schedules C and F primarily reflect businesses where the taxpayer is directly and actively involved.

There are several exceptions to PAL Limitations:

• Exception for Real Estate Professionals (§ 469(c)(7)): There is a significant exception for individuals who qualify as “real estate professionals.” If they meet specific rigorous criteria regarding their involvement in real property trades or businesses, their rental activities are not automatically treated as passive. If they also materially participate in those rental activities, any losses generated can be deducted against active or portfolio income, bypassing the PAL limitations.
• $25,000 Special Allowance for Rental Real Estate (§ 469(i)): For taxpayers who “actively participate” in rental real estate activities,  which is a lower standard than material participation, may deduct up to $25,000 of passive rental losses against non-passive income. This allowance phases out for higher-income taxpayers.
• Publicly Traded Partnerships (PTPs) (§ 469(k)): PTPs have a unique rule: passive losses from a specific PTP can only offset passive income from that same specific PTP. These losses cannot offset passive income from other PTPs or other non-PTP passive activities. Suspended PTP losses are also only deductible when income is generated by that specific PTP or upon the full disposition of the interest in that specific PTP.

Noncorporate taxpayers (individuals, estates, and trusts) who have passive activity losses subject to these limitations must use Form 8582, “Passive Activity Loss Limitations,” to calculate the amount of passive loss allowed for the current tax year. Form 8582 aggregates income and losses from all passive activities to determine the overall limitation. The allowable loss calculated on Form 8582 is then transferred to the appropriate lines on Schedule E.

See video for Form 8582 – Passive Activity Loss limitations walkthrough.

Excess Business Loss Limitation (§ 461(l)):

Noncorporate taxpayers (including individuals, estates, and trusts) are subject to a limitation on the amount of deductible business losses. This limitation, known as the excess business loss limitation, restricts the total amount of net business losses that can offset other income. These amounts of limitation are adjusted annually for inflation and reported on Form 461 Part III. Business losses include those from sole proprietorships, partnerships, and S corporations. Any business losses exceeding these thresholds are considered excess business losses and are not deductible in the current year. Instead, these excess losses are treated as net operating losses (NOLs) and can be carried forward to future tax years.

See video for Form 461 – Limitation on Business Losses walkthrough.

Income from pass-through entities is a significant component of many individuals’ taxable income. While these structures offer the benefit of passing through losses, the deductibility of these losses is subject to several complex limitations under the Internal Revenue Code. Understanding the basis limitations, at-risk rules, passive activity loss rules, and the excess business loss limitation is crucial for effective tax planning for individuals involved in pass-through entities. Careful tracking of basis amounts at risk, and the level of participation in business activities is essential to maximize the deductibility of losses and manage overall tax liability.

Tax Planning Considerations

Effective tax planning for income and losses reported on Schedules C, E, and F requires attention to timing, characterization, and the interaction of loss‑limitation rules with deduction regimes such as the Section 199A QBI deduction. For Schedule C taxpayers, consider retirement plan contributions (for example, SEP IRAs, SIMPLE IRAs, or solo 401(k) plans) and business expenses that are deductible under IRC §162 to reduce taxable self‑employment income while simultaneously supporting retirement savings. Careful management of depreciation, including Section 179 and bonus depreciation choices, as well as the timing of deductible purchases, and estimated tax payments, can smooth taxable income across years and affect both self‑employment tax and QBI calculations.

With Schedule E items, tax planning often focuses on the classification of activities and the material participation facts that determine whether rental results are passive under IRC §469. Taxpayers who qualify as real estate professionals or who satisfy material participation tests can change the loss‑utilization landscape, permitting rental losses to offset nonpassive income in some circumstances. Basis and at‑risk considerations are central: increasing capital contributions or documenting bona fide loans can create additional basis or at‑risk amounts (IRC §465), which may unlock otherwise suspended losses. When losses are suspended under passive or at‑risk rules, consider whether grouping elections, strategic disposition of interests, or timing capital transactions can accelerate the use of suspended deductions.

Farm taxpayers using Schedule F should evaluate accounting‑method choices, inventory valuation, and the timing of crop sales and government payments to manage taxable income volatility. Depreciation elections, the use of Section 179 expensing where applicable, and careful treatment of crop insurance and disaster receipts can materially affect the recognition of taxable income in a given year. Because net farm income may be subject to self‑employment tax (IRC §1402), farmers should also weigh the interaction of net income with estimated tax requirements and retirement plan contribution opportunities available to self‑employed persons.

Across all schedules, loss‑limitation regimes shape planning opportunities. Monitor K‑1s and reconcile entity information promptly so that basis, at‑risk, and passive‑activity positions are tracked in real time. Where excess business loss limits (IRC §461(l)) or hobby loss rules (IRC §183) might apply, plan transactions with an eye toward preserving deductions or converting disallowed amounts into usable NOLs under IRC §172. When suspended losses exist, consider whether a taxable disposition, contribution of additional capital, or creation of passive income will permit deduction in a future year.

For taxpayers seeking to maximize the Section 199A QBI deduction, planning should address both qualification and limitation buckets. Confirm that the activity constitutes a trade or business and not a hobby; determine whether it is a specified service trade or business (SSTB) for threshold purposes; and evaluate the wage and qualified‑property limits. For higher‑income taxpayers, adding W‑2 wages or increasing the unadjusted basis of qualified property can expand the QBI deduction, but such measures carry tradeoffs and compliance obligations. Aggregation elections available under the QBI regulations may allow taxpayers to combine related trades to meet threshold tests but require careful documentation and consistent application.

Finally, effective planning requires coordination with overall tax objectives and an awareness of changing law. Maintain records of contributions, distributions, loans, material participation facts, and K‑1 reconciliations; run preliminary tax calculations across alternative scenarios (for example, accelerate expenses vs. defer income, or increase basis vs. take losses now) to see the effect on AGI, payroll/self‑employment exposure, and QBI.