If a new business is expected to lose money during the first years of operation, consider a sole-proprietorship, Limited Liability Company, partnership, or S corporation entity. Losses from these types of entities (limited to the basis in the business) offset other income from salaries, investments, and other businesses. If the losses exceed the other income they generate net operating losses that can be carried back two years or forward twenty years.
Specific Details
The parents reduced their taxable income by $5,000 by using losses from single-tax entities to offset their other income from salaries and investments. Since the parents income was taxed at the 30% tax bracket, the income reduction may decrease their income taxes by $1,500 ($5,000 x 30%).
Potential Savings
If you are in a combined (federal, self-employment, and state) tax bracket of 30%, you could reduce your taxes up to $300 for every $1,000 of income reduction by using losses from single-tax entities to offset your other income.