Prior to the enactment of the Tax Cuts and Jobs Act (TCJA), the largest tax overhaul in decades, individuals could freely deduct their flow-through business losses from their partnerships and S corporations against their wages and other investment income, subject to basis, at risk and passive activity limitations. As a result, a taxpayer with sufficient business losses, could avoid paying any income taxes in a given year with a proper planning and guidance.
For taxable years beginning after December 31, 2017 and before January 1, 2026, excess business losses (EBL) of a taxpayer other than a corporation are only allowed up to the total business income and gain, plus a threshold amount of $500,000 for married filing jointly and $250,000 for individuals. This new limitation is applied after subjecting the business loss to the basis, at-risk, and passive activity limitations. Thus, the release of a suspended passive loss due to a disposition of the underlying passive activity will still be subject to the EBL limitation. Any disallowed business loss is carried over and treated as a net operating loss (NOL) and further limited to 80% of taxable income under section 172(a)(2).
One advantage of this new loss provision is that it allows the taxpayer to avoid using ordinary losses to offset capital gains in certain circumstances.
Prior to the enactment of the TCJA, corporations were allowed a two-year carryback and a 20-year carryforward of their NOLs. Corporations were also eligible to fully offset their “regular” taxable income against the NOL carryover, as long as they were not limited and the taxpayer was not subject to the alternative minimum tax (AMT). Under the new tax rules, the NOL carryback is eliminated and the carryforward is indefinite. The AMT is repealed for the corporations but not for the individuals. The new rules state that the NOL that may be deducted in a single tax year is limited to the lesser of the available NOL carryover or 80% of the corporate taxable income before the NOL deduction.
The new corporate NOL provisions apply only to losses arising from tax year after December 31, 2017. The pre-2018 NOLs are still allowed to be utilized under the old regime. As such, a corporate taxpayer with NOL carryovers to a taxable year from both taxable years beginning before 2018 (pre-2018 NOL carryovers) and taxable years beginning after 2017 (post-2017 NOL carryovers) is entitled to first fully utilize the pre-2018 NOL carryovers with no limitation. Second, the taxpayer is entitled to an additional NOL deduction equal the lesser of the following:
1. The post-2017 NOL carryovers; or
2. 80% of the excess (if any) of the taxpayer’s taxable income (before any NOL deduction attributable to post- 2017 NOL carryovers) over the NOL deduction attributable to pre- 2018 NOL carryovers.
Needless to say, the TCJA has created additional limitations for the taxpayers to be able to deduct their business losses. Planning around these various limitations without the proper guidance could be challenging and may even be costly. If you have questions regarding the deductibility of business loss provisions, please contact Simon Bencheqroun or one of our experienced tax advisors today at 301.231.6200.