Loss Limitation for Noncorporate Taxpayers

Initially, the Tax Cuts and Jobs Act (TCJA) of 2017 introduced the excess business loss (EBL) limitation which was effective for tax years 2018 to 2025. In 2020, the Coronavirus Aid, Relief and Economic Security (CARES) Act retroactively delayed the EBL limitation to tax year 2021. Taxpayers who filed 2018 and 2019 tax returns with losses limited by EBL limitation could amend those returns to fully claim the applicable business losses. Although the implementation of the EBL limitation was delayed by two years, it was subsequently extended by three years as part of the American Rescue Plan Act (ARPA) of 2021 and the Inflation Reduction Act (IRA) of 2022. This makes the EBL limitation effective for tax years 2021 to 2028.

Noncorporate taxpayers may have business losses limited due to EBL limitation. A taxpayer’s passive activity limitations, at-risk limitations and tax basis limitations are applied before the EBL limitation. To determine the EBL limitation, the taxpayer must first aggregate trade or business deductions or losses with their trade or business income or gain for the tax year. Second, the aggregated trade or business net losses are limited to an annual threshold amount which is indexed for inflation. The annual threshold amounts for tax years 2021-2023 are as follows:

To the extent that net trade or business losses exceed the EBL annual threshold amount, the result is a Net Operating Loss (NOL) which is carried forward indefinitely until used. The taxpayer may use the NOL, subject to the NOL rules, to offset taxable income in a subsequent tax year. NOLs generated from tax year 2021 going forward are limited to 80% of taxable income computed without the allowable NOL.

EBL Limitation Planning Considerations

The initial year of the EBL limitation could cause a significant amount of unforeseen income tax to a taxpayer in a tax year where the taxpayer has experienced financial hardship from sustained losses. It is imperative to take this into consideration with year-end tax planning. Since an NOL deduction can offset up to 80% of taxable income in the following year, it could be beneficial for the taxpayer to defer non-trade or business income to the tax year following the EBL year. For instance, deferring a significant non-trade or business capital gain or installment sale income to the following year could potentially be much more tax advantageous because up to 80% of the taxable income can be reduced by the NOL carryover. Any potential ownership changes, special allocations of income or loss, or other income or loss recognition events should be closely monitored to ensure proper coordination with any EBL limitation facing the taxpayer.

If you have any questions regarding EBL limitation, please reach out to Kyle Krenske at Mahoney.

Additional Reading: Learn more about the CARES Act

EBL Limitation Planning Considerations

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