With Covid-19 relief measures expiring across the board, taxpayers should be aware that the limitation on “excess business losses” (EBLs) is now in effect. This limitation is expected to impact many taxpayers and hinder their ability to offset taxable income with business losses. The EBL limitation was originally enacted by the TCJA and scheduled to apply to tax years 2018 through 2025. However, the CARES Act retroactively postponed the limitation until 2021, and the ARPA extended the limitation through 2026.
The limitation disallows any EBL of a non-corporate taxpayer. For 2021, EBLs are trade or business losses that exceed trade or business income (without regard to any deduction for Qualified Business Income or Net Operating Losses) by more than $524,000 for married individuals filing jointly or $262,000 for other taxpayers. In the case of a partnership or S corporation, the EBL limitation applies at the partner or shareholder level. Each partner’s or shareholder’s allocable share of trade or business income or loss is taken into account in applying the EBL limitation to such partner or shareholder.
Disallowed EBLs are treated as Net Operating Loss carryovers to the following tax year. Accordingly, the carryforward amount will not factor into the following year’s EBL limitation and the disallowance generally operates as a one-year deferral. (Note, however, that various versions of the Build Back Better Act have contained provisions under which the EBL would retain its character as a trade or business loss and be subject to annual testing under the limitation – potentially postponing deduction of the EBL over multiple years).
Some things to note:
- The EBL limitation applies after the application of (1) the passive activity loss limitation and (2) the at-risk loss limitation. Thus, if a loss is disallowed under either limitation, the loss will not be taken into account in applying the EBL limitation.
- Employee wages aren't taken into account in computing the EBL, so EBLs cannot shelter employment income. It is unclear whether guaranteed payments from a partnership are taken into account in computing the EBL.
- When calculating the EBL limitation, taxpayers take into account the lesser of: (1) capital gain net income attributable to a trade or business, or (2) capital gain net income. Capital losses are not taken into account.
- It is unclear whether gain or loss from the disposition of an interest in a partnership or S corporation conducting an active trade or business would be taken into account in computing the EBL. We will advise as future guidance becomes available.
If you have any questions or believe that this limitation may impact you, please reach out to an HBK Tax Adviser.