Tax Reform: Changes to Business Loss and Net Operating Loss Deductions

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the third of a series of articles reviewing some of the more important changes.  This post deals with changes to the deduction of nonpassive business losses and to net operating losses.

Current Year Excess Aggregate Net Business Losses

Excess aggregate net business losses of individuals and trusts/estates are not allowed for the year of loss.  This is a significant but not well publicized change for those who are impacted.  The excess business loss limitation sunsets after 2025.

·      An excess business loss is the amount over $500,000 MFJ or $250,000 for other individuals and trusts/estates.  Thus, other income such as wages or portfolio income cannot be sheltered from income tax to the extent of the excess loss.

·      The excess loss is treated as a NOL carryforward even if the taxpayer doesn’t otherwise have an actual NOL for the year.  Treating excess losses as part of a NOL limits the future deduction to 80% of taxable income.  See discussion below.

·      Business losses can arise from a sole proprietorship, a partnership, or an S corporation.  The determination is made at the partner and S corporation shareholder level.

·      The excess business loss is a new, fourth loss limitation rule:  1) tax basis, 2) at-risk basis §465, 3) passive activity loss §469, and 4) excess business loss §461(l).

Net Operating Losses

NOLs generated in tax years beginning after 2017 may only be carried forward and not carried back to earlier tax years to get a tax refund.  An exception is provided for certain farm losses.  The NOL changes are permanent and do not sunset.

·      Post-2017 generated NOLs will have an indefinite carryover period instead of the current 20-year carryover period.

·      However, post-2017 generated NOLs may only offset 80% of taxable income.

·      Pre-2018 NOLs are grandfathered and can offset 100% of taxable income and can also be carried back.  Therefore, depending upon facts and circumstances, it may be good tax planning to make the 2017 NOL as high as possible.