Tax Reform Puts a Cap on Deducting Business Losses

Article Highlights:

• Excess Business Loss
• Computing the Loss Limits
• Net Operating Losses (NOL)
• NOL Carryovers

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

Under the Act, deductible business losses of noncorporate taxpayers will be limited beginning in 2018. Many have misconstrued this new law to mean that no losses are allowed.

Fortunately, that is not the case. The Act does not allow “excess business losses” to be deducted. An “excess business loss” is the excess of the taxpayer's aggregate trade or business deductions for the tax year (determined without regard to whether the deductions are disallowed for that tax year) over the sum of the taxpayer's aggregate gross income or gain for the tax year from those trades or businesses, plus $250,000 (200% of that amount for a joint return (i.e., $500,000)). This amount will be adjusted for inflation after 2018.

More simply put, deductible losses for the year are generally limited to $250,000 ($500,000 for married couples filing jointly).

Example: A single taxpayer, in 2018, has two businesses. The combined deductions from the two businesses total $500,000. The taxpayer’s gross income from those two businesses is $200,000. After netting the income and deductions, there is a net loss of $300,000 ($200,000 – $500,000). Prior to the Act, the deductible loss would have been $300,000. However, under the Act the excess business loss is equal to $50,000 ($500,000 – ($200,000 + $250,000)). And since excess business losses are not deductible, the taxpayer can only deduct $250,000 ($300,000 – $50,000) in 2018.

On the bright side, the nondeductible excess business loss ($50,000 in our example) is treated as a net operating loss (NOL) carried forward to the next year’s return, where it is deductible from the taxpayer’s gross income, including nonbusiness income. Under the Act, an NOL is carried forward indefinitely until it is used up. The Act did, however, limit NOLs in the future to offsetting only 80% of a taxpayer’s income for any year.

If you have questions related to “excess business loss,” please give this office a call.