It’s not uncommon for businesses to sometimes generate tax losses. But the tax law limits deductible losses in some situations. And the Tax Cuts and Jobs Act (TCJA) further restricts the amount of losses that sole proprietors, partners, S corporation shareholders and, typically, limited liability company (LLC) members can now deduct. If your company operates under one of these business structures, it’s important to bear all these limitations in mind as the year rolls along.

Before and After

Under pre-TCJA law, an individual taxpayer’s business losses could usually be fully deducted in the tax year when they arose unless the passive activity loss (PAL) rules or some other provision of tax law limited that favorable outcome. Another restriction was if the business loss was so large that it exceeded taxable income from other sources, creating a net operating loss (NOL).

The TCJA temporarily changes the rules for deducting an individual taxpayer’s business losses. If your pass-through business generates a tax loss for a tax year beginning in 2018 through 2025, you can’t deduct an “excess business loss” in the current year.

An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of your aggregate business income and gains for the tax year, plus $250,000 ($500,000 if you’re a married taxpayer filing jointly). The excess business loss is carried forward to the following tax year and can be deducted under the rules for NOLs.

What it Means

For business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes, the new excess business loss limitation rules apply at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on the owner’s personal federal income tax return for the owner’s tax year that includes the end of the entity’s tax year.

Keep in mind that the new loss limitation rules kick in after applying the PAL rules. So, if the PAL rules disallow your business or rental activity loss, you don’t get to the new loss limitation rules.

Practical Impact

The rationale underlying the new loss limitation rules is to restrict the ability of individual taxpayers to use current-year business losses to offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains.

The practical impact is that your allowable current-year business losses can’t offset more than $250,000 of income from such other sources (or more than $500,000 for joint filers). The requirement that excess business losses be carried forward as an NOL forces you to wait at least one year to get any tax benefit from those excess losses.

Potential Effect

If you’re expecting your business to generate a tax loss in 2019, we can help you determine whether you’ll be affected by the new loss limitation rules.

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Matt Eckelberg
I joined Hawkins Ash CPAs in 1997. I began as an intern and have advanced to partner. I have thorough experience in audit and tax and provide these services to commercial entities, individuals, and profit-sharing 401(k) plans. I am a former member of the firm’s tax committee.

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