Tax Reform: Excess Business Losses

Pass-through business owners historically were able to deduct excess business losses, allowing them to reinvest that money into their businesses. The Tax Cuts and Jobs Act (TCJA) has made significant changes to the treatment of excess business losses that could negatively affect taxpayers. Below we cover what has changed and how business owners will be impacted.

Previous Law

Under the previous law, only passive losses and excess farm losses were limited. Non-passive losses from a trade or business were not limited.

New Law

Under the new tax law, all passive and non-passive activities are subject to the limitations under the excess business loss law. Passive losses must first apply the limitations under IRC Sec 461 prior to the excess business loss limitation. Any business losses, passive or non-passive, in excess of the threshold will be disallowed and carried forward indefinitely as a NOL in subsequent years. The threshold is determined by deductions exceeding income in excess of $250,000, or $500,000 for a married filing joint filer. The excess business loss is not applicable to C corporations.

Example

Let’s assume the following facts to illustrate the impact of the excess business loss limitation. A single taxpayer generates gross income from his business in the amount of $325,000. His deductions from the business total $600,000 netting his activity to a $275,000 overall loss. The taxpayer has an excess business loss in the amount of $25,000, which is the $275,000 overall loss reduced by the $250,000 threshold. The $25,000 loss is treated as part of his net operating loss carryforward to be used in future years and will be subject to the 80% of taxable income limitation.

Impact on Individuals

This change in conjunction with the NOL rule changes, could have a hugely negative impact on taxpayers. If a taxpayer were to have an abnormally bad business year, while still maintaining large investment income, they could still owe a significant amount of tax, rather than investing that money used to pay the tax into their business.

In addition, NOL’s are only allowed to offset 80% of taxable income, so these losses may be limited in future years as well, based on the subsequent year earnings.

Visit our Tax Reform Resource Center for videos, blog posts and resources on how tax reform will impact you, your family and your business. Contact an Anders advisor with questions on how the new tax law will affect you.