Introducing: the new business loss limitation

  iStock

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Posted by Evan Piccirillo, CPA

A new provision included in the Tax Cuts and Jobs Act introduces the concept of excess business losses (EBLs). Beginning in tax years starting after December 31, 2017, a tax deduction for losses from business activities that exceed $250k for single filers and $500k for married filers are considered EBLs and will be disallowed.

Digging into this piece of hastily-written code section we don’t find much in the way of details, but we do get some important information:

  1. The EBL converts to a net operating loss (NOL) in the following year

  2. EBLs are figured by aggregating the income and loss from trades or businesses that exceed the limit

  3. The limits of $250k and $500k are indexed for inflation

  4. The limitation is applied at the partner or shareholder level in the case of a partnership or S corporation, respectively

  5. The EBL is figured after the other business loss limits: basis, at-risk, and passive activity

  6. This provision is set to expire in 2026

What does it all mean?

Taxpayers may not be able to shelter as much of their other types of income with losses from their active trades or businesses. Also, the NOLs generated from these EBLs are the new flavor of NOL which cannot be carried back, will be carried forward indefinitely, and are limited in their usage to 80% of taxable income. These NOLs are less potent than their predecessors, but the upside is that they don’t expire. We’ll have more on the NOL topic in a future article.

What don’t we know?

  • Does this limitation apply to trusts? The prevailing belief is that it does.

  • Are wages and/or guaranteed payments from sources subject to this limit considered to be trade or business income and therefore aggregated to figure the EBL? It seems they should be included, but this requires further guidance.

  • Will other items of income and loss such as interest income or 1231 gains/losses from sources subject to this limitation be aggregated to figure the EBL? This is also unclear and will require further guidance.

Let’s take a look at a simplified example:

A single taxpayer has nonbusiness income of $400k and net allowable business losses of $350K. Under these circumstances in 2017, this taxpayer would be able to shelter most of their income with the business losses and only pay tax on $50k of income ($400k - 350k = $50k). With the same set of facts in 2018, the taxpayer’s business losses will be limited to $250k and tax will be paid on $150k ($400k – 250k = $150k), resulting in a $100k swing in income. The EBL of $100k will convert to a NOL to be used in future years, which is nice, but this taxpayer still needs to pay tax presently on an extra $100k of income. Not an ideal outcome for our hypothetical taxpayer.

This limitation adds yet another layer of complexity to an already complex tax planning landscape. If your tax situation resembles what you have just read, you should consult with your tax advisor to see if there is anything you can do before the end of the year to account for this potentially expensive tax consequence.