In the midst of all the changes associated with the Tax Cuts and Jobs Act (TCJA), one change that may not be top of mind for taxpayers and tax preparers alike is the implementation of the new excess business loss (EBL) limitations. In general terms, Internal Revenue Code (IRC) Section 461 was amended to include subsection (l), which limits EBLs on all noncorporate taxpayers—e.g., individuals, trusts and estates—to $250,000 ($500,000 married filing jointly). This limitation is effective for taxable years beginning after December 31, 2017, and before January 1, 2026.
The basic calculation of the EBL is the aggregate of business deductions over the sum of the aggregate gross income attributed to trades or businesses of the taxpayer, limited to a $250,000 loss ($500,000 married filing jointly). This calculation combines multiple business interests to get to the combined business loss limitation that is then used to offset nonbusiness income. IRC §461(l) is conceptually similar to existing §461(j), which limits excess farm losses attributable to farming businesses of a taxpayer. The §461(l) limitation amounts will be adjusted for inflation annually for taxable years beginning after December 31, 2018. For partners in a partnership or shareholders in an S corporation, this limitation is taken into account at the individual level.
Example: A single taxpayer has $300,000 of interest and dividends, $500,000 of negative ordinary income from a partnership and $100,000 of ordinary income from an S corp with active participation in both business interests. Under pre-TCJA rules, this would be a $100,000 taxable loss for the taxpayer ($300,000 - $500,000 + $100,000). Under the new rules, the two business interests are first combined to get to a loss of $400,000, which is limited to $250,000 under EBL limitations and can then be used to offset the $300,000 of nonbusiness income for a net positive income of $50,000. The calculation of the EBL would be included on the individual tax return Form 461, Limitation on Business Losses, which would be attached to the taxpayer’s Form 1040.
The disallowed loss in excess of the new limitation—the $150,000 ($400,000 - $250,000) in the example above—is not permanently lost but is instead carried forward as a net operating loss (NOL). The TCJA also made changes to the NOL rules under §172. For taxable years ending after December 31, 2017, the two-year NOL carryback is no longer in effect for most taxpayers, NOLs are limited to 80 percent of the pre-NOL taxable income and NOLs are carried forward indefinitely. Take a look at BKD’s helpful summary on NOLs under the TCJA for more information.
It’s important to note the EBL limitations are applied after other existing loss limitation rules, i.e., tax basis limitations, at-risk limitations and passive activity loss limitations. In the example above, the taxpayer would still need to have the tax basis and at-risk basis necessary to take the $500,000 of losses from the partnership. Also, if the two interests were both passive, the combined $400,000 of passive losses would be disallowed under §469 before the EBL limitations are taken into account.
The addition of §461(l), applicable to all noncorporate taxpayers, has led to many unanswered questions and requests for additional guidance that in many cases we’re still waiting on. For example, additional clarification on whether wage income and guaranteed payments are considered trade or business income for purposes of §461(l) is still needed. It’s been a precedent in other areas of the tax law that individuals who are employees are considered to have trade or business income. However, the General Explanation of the Public Law 115-97 explicitly states it was not intended for wage income to be included in the calculation. A footnote said it may take a technical correction to carry out this rule. As of the time of publishing this article, there has not been a technical correction issued on this section of the law.
Example: If we were to add $100,000 of wages to the example above, and if wages were classified as business income for purposes of §461(l), the existing $400,000 of business losses would be used to offset wages and then limited to $250,000 to offset the interest and dividends for a net taxable income of $50,000 and NOL carryover of $50,000 ($100,000 - $400,000 + $250,000). If additional clarification suggests wages are not included as business income for purposes of §461(l), the $400,000 loss would be limited to a $250,000 loss to offset the $300,000 of interest and dividends and $100,000 of wages, for a net taxable income of $150,000 and NOL carryover of $150,000.
Other areas where we need additional guidance include whether gains (capital and ordinary) or losses on the sale of business property or the disposition of an interest in a partnership or S corp are included or excluded as trade or business income or deductions for purposes of §461(l).
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