Our latest Tax Reform Advisor applies to excess business losses, which most directly relates to individuals and the deductibility of business losses from sole proprietorships and pass-through entities – S-corporations and partnerships.

Background

Previously, the rules for excess losses were limited to farm losses if the taxpayer had received an applicable subsidy. Now the rules and limitations on excess business losses apply to all non-corporate taxpayers.

New Law

For tax years beginning after December 31, 2017, and before January 1, 2026, individuals and other non-corporate taxpayers, including trusts and estates who operate an active trade or business, must treat their “excess business losses” as Net Operating Loss (NOL) carryforwards. An excess business loss is essentially the excess of a taxpayer’s deductions attributable to trades or businesses over the aggregate gross income from those trades or businesses, plus a threshold. For partnerships and S-corporations, the limitation applies at the partner or shareholder level.

What Does This Mean?

Essentially, this new rule will limit the ability to use business losses to offset other income such as wages and interest; however, there are established thresholds for the limitation which will allow the offset of some of a taxpayer’s other income ($500,000 for married couples filing jointly, and $250,000 for all other filers). In determining whether a taxpayer has an excess business loss, the rules are applied to the aggregate income and deductions from all trades or businesses included on the tax return (including a spouse’s in the case of a married filing joint return).

If, after applying these thresholds, a taxpayer has an excess business loss, the taxpayer must carry that loss forward to subsequent years in the same manner as a NOL. Keep in mind that the existing rules regarding basis and passive activity losses and their limitations are applied in making the determination of whether you have an excess business loss.

Below is an example of how this new provision works.

  • In 2018, Jay, a single taxpayer, has gross business income of $200,000, deductions of $500,000, for a net business loss of $300,000. Jay’s excess business loss is $50,000 ($300,000 less $250,000 threshold for single taxpayer). The $50,000 excess business loss is treated as part of the taxpayer’s NOL carryforward in later years.
  • If Jay was married, there would be no excess business loss due to the increased threshold of $500,000.

Net Operating Losses

Under the new law, all NOLs must now be carried forward (no option to carryback two years.)  The new law also provides that NOL carryovers may only offset up to 80% of taxable income in each subsequent year.  This new provision limits the value of NOLs because they may no longer eliminate taxable income in subsequent years.

We are here to help you better understand the complexities of this limitation and calculate the impact to you.

About the Authors

Cindy H. Mitchell

CPA
Senior Manager, Taxation Services

Jessica L. Tepus

CPA
Senior Manager, Taxation Services

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