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The Excess Business Loss Limitation: Opportunities and Clarifications from the CARES Act

By: John V. Aksak Ryan McKenzie Jason Carter |

Summary

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted on March 27, 2020 and included many economic relief measures as summarized in previous True Alerts (Tax Issues Addressed by COVID-19 Emergency Legislation; Congressional Action on the COVID-19 Pandemic: The CARES Act).  This True Alert will focus on temporary elimination of the “excess business loss” limitations for taxable years 2018, 2019, and 2020.

Background

The Tax Cuts and Jobs Act (TCJA) enacted §461(l), also known as the excess business loss limitation rule, which limits the amount of business losses that a noncorporate taxpayer can deduct in the current year.  As originally drafted, the limitation applied to tax years beginning after December 31, 2017, and before January 1, 2026.

The excess business loss is the amount of aggregate of trade or business deductions that exceed the sum of the aggregate trade or business gross income or gain plus a threshold amount ($250,000, or $500,000 if married filing jointly, both of which are adjusted for inflation) per tax year.

For partnerships, S corporations, and other pass-thru business entities, the loss limitation are applied at the partner/shareholder level, not at the entity level.  Any disallowed loss shall be carried over to the subsequent tax year and treated as a net operating loss carryforward.

Post-Cares Act §461(l):

The CARES Act modified § 461(l) by:

  1. Eliminating the excess business loss limitation rule for the 2018, 2019, and 2020 tax years;
  2. Clarifying that deductions under §§ 172 and 199A are not taken into account in determining the amount of a taxpayer’s deductions used to calculate its excess business loss;
  3. Providing that neither deductions, gross income, nor gains from employee services are included in the excess business loss calculation; and
  4. Adding provisions relating to the application of capital gains and losses in determining a taxpayer’s excess business loss.

Retroactive or Prospective?

Retroactively, the CARES Act removes all limits on excess business losses for tax years 2018 and 2019.  Prospectively, it does the same for tax year 2020. Likewise, the amendments regarding W-2/employee income and capital gains and losses shall apply as if they were originally part of the TCJA, making those changes both retroactive and prospective.

Opportunity and Next Steps:

With the amendments from the CARES Act, the excess business loss limitation is repealed for tax years beginning before January 1, 2021.  The repeal is nonelective, and failure to amend a return that was filed with a loss that was limited under §461(l) may result in losing the benefit of the loss because it may no longer be available to carry forward to future years.  Therefore, taxpayers who filed 2018 or 2019 tax returns including loss subject to §461(l) should consult their tax advisor and develop a strategy to maximize the benefit of those losses and determine whether its beneficial to amend previously filed tax returns.

Please contact a member of your TPC engagement team if you have any questions about this topic or to learn more about how TPC can help.