The Tax Cuts and Jobs Act (“TCJA”) imposes a new limit on the deductibility of business losses incurred by taxpayers other than corporations. A taxpayer’s loss from a non-passive trade or business is now limited to $500,000 for married individuals filing jointly ($250,000 for other taxpayers) for tax years beginning after December 31, 2017 and before January 1, 2026.
These amounts are indexed for inflation for tax years beginning after December 31, 2018. Any excess business loss is treated as part of the taxpayer’s net operating loss (“NOL”) carryforward to be used in subsequent years.
Excess business losses are the taxpayer’s excess deductions from trades or businesses over the taxpayer’s income from trades or businesses, plus the statutory threshold amount described above. Excess business losses for a partnership or S-corporation are determined at the partner or shareholder level. Thus, each partner or shareholder’s share of items of income, gain, deduction, or loss of the entity is taken into account in determining the partner or shareholder’s limitation.
The determination of a taxpayer’s excess business loss is determined after applying the passive loss rules. Disallowed excess business losses will be treated as an NOL and carried forward under the NOL carryforward rules.
A married taxpayer has taxable wages of $1,000,000 and a net loss from trades or businesses of $2,000,000, of which $500,000 are passive losses and $1,500,000 are losses from active trades or businesses.
The excess business losses will be $1,000,000 (aggregate deductions from trades or businesses of $1,500,000 over the sum of $0 aggregate gross income from such trades or business plus $500,000), and these are carried forward as an NOL.
The taxpayer will also have a passive loss carry-forward of $500,000 and a current year business deduction of $500,000. This means the taxpayer will have adjusted gross income of $500,000 (taxable wages of $1,000,000 less $500,000 allowable loss from active trades or businesses).
Prior to enactment of the TCJA, the taxpayer would have had the passive loss carryforward of $500,000, but their adjusted gross income would have been a loss of $500,000 ($1,000,000 of wages less $1,500,000 of non-passive losses).
Treasury is directed to issue additional reporting requirements it determines as necessary to carry out the purpose of the provision.
The TCJA also modified certain rules with respect to net operating losses. An NOL can no longer be carried back two years. In addition, they can now be carried forward indefinitely as opposed to being limited to 20 years. Finally, NOLs can only be used to offset 80% (instead of 100%) of a taxpayer’s taxable income in a carryforward tax year. These changes to the NOL rules are effective for tax years beginning after December 31, 2017.
As a result of the TCJA, taxpayers with income from sources other than active trade or business income may now have taxable income, as opposed to reporting a taxable loss due to the limitation on excess business losses, coupled with the limitation of available NOLs after December 31, 2017 to 80% of pre-NOL deduction taxable income.
Please consult your Mazars USA LLP professional for additional information.