Accounting On Us
New excess business loss limitation rules
Tax reform brings big changes
Jeremy Smith, CPA
As if there weren’t already enough changes under the new tax law, the Tax Cuts and Jobs Act (TCJA) expanded the loss limitations already in place to also apply to noncorporate taxpayers engaged in all types of trades or businesses for taxable years starting after December 31, 2017. The new excess business loss rules create a loss limitation that must be considered in your tax planning and integration with all the other new tax law changes.
Old law vs new law
The old law was quite different from the new law. Under the old law, there was a loss limitation for excess farm losses, which above a certain threshold, couldn’t be deducted in the current year and had to be carried forward. The new law scrapped the definition of excess farm losses and replaced it with excess business losses. So now, the law includes farms plus all other noncorporate taxpayers.
The new excess business loss limitation rules apply to noncorporate taxpayers, which is any taxpayer other than a C Corporation. Partnerships, S Corporations, sole proprietors, etc. could have losses from a trade or business, or multiple trades or businesses. For these partners or shareholders, the excess business loss limitation is taken into account on their individual tax return.
What is an excess business loss?
An excess business loss is the excess of the aggregate deductions over the aggregate income for the tax year that is attributable to trades or businesses of the taxpayer. If the excess business loss is greater than $500,000 for married individuals filing jointly, or $250,000 for other individuals, the “excess” is carried forward into future tax years.
In essence, when you net all of that together, the maximum loss you can take is either $250,000 or $500,000 – depending on your filing status. The practical result is that the business losses for a noncorporate taxpayer for the tax year can offset no more than $250,000 or $500,000 of nonbusiness income for the year.
What if I have an excess business loss?
Excess business losses are really the fourth disallowance provision behind the three that we have already known about for years. As a reminder, you must first navigate the other disallowance provisions that were already in place before the new tax law was passed:
- Tax basis
- At-risk basis
- Passive activity loss rules
Whatever makes it through these layers is what you would apply the excess business loss limitation to.
Any disallowed excess business losses from the current year will be treated as a net operating loss (NOL) and carried forward. Reminder: NOLs are no longer able to be carried back. They can only be carried forward and are limited to offsetting 80% of taxable income in the next year.
As of this article, there are several items for these rules that still need clarification, particularly what is included in business income:
- Are wages and guaranteed payments considered business income?
- Is interest generated from a business considered business income?
- Are the gains and losses from the sale of business assets included?
- How does the new Section 199A deduction interact with the excess business loss calculation?
If you have business losses and some of these unknowns apply to your situation, be sure to reach out to your Henry+Horne tax advisor.
Tax planning opportunities
We, like you, are continuing to look for opportunities with the new tax law. While we are both getting comfortable with the new modus operandi, here are some questions to be considered when planning for your tax situation going forward:
- How do I coordinate the new generous depreciation rules with the limitations of excess business loss rules?
- Can I plan my large capital asset additions in a year that has much higher anticipated income?
- What is a reasonable wage and/or guaranteed payment? Will they be taken into consideration under this provision of the new tax law?
- Should I review the interest rate on loans I have made to the company?
- Should I review my accounting method?
The new tax law is in effect from December 31, 2017 until January 1, 2026. When it expires, the excess business loss limitation rules will revert back to the previous law, meaning it will once again only apply to farmers – unless Congress extends the provision.
As always when there’s a huge tax overhaul, there are constant updates, clarifications, etc. – we will keep you updated as new information comes down. You can subscribe to our Tax Insights blog to get the latest tax news delivered straight to your inbox every week.