New Tax Law Limits Business Losses

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Two provisions of the Tax Cuts and Jobs Act (TCJA) restrict the ability of taxpayers to benefit from losses incurred in their business operations. This alert discusses excess business losses, new rules that limit individuals from fully deducting business losses against salaries, investments, and other income on that same year's return. Next week we will cover TCJA restrictions on the net operating loss (NOL) deduction, which lets an individual or company with overall losses in one year reduce income reported in a different year.


Excess Business Losses

Under prior law, taxpayers could deduct most losses sustained in a business (such as a sole proprietorship or a share of a pass-through entity) on their return for that year. Restrictions applied when the owner was not active in the business or if he didn't have any of his own investment in it. But once those hurdles were met, the loss could reduce any other income on the return (such as wages or interest income).


Starting in 2018, net business losses can only offset $250,000 of income from non-business sources. Any loss greater than $250,000 is disallowed in that year and treated as an NOL carryover. For example, if a business you report on Schedule C of your 2018 Form 1040 shows a $400,000 net loss, prior law allowed you to deduct $400,000 against other income. If your only other income was $400,000 of salary, your adjusted gross income would be zero and you would pay no tax.


Now, you can only deduct $250,000 of that loss in 2018. Your adjusted gross income will be $150,000 ($400,000 salary less $250,000 allowed loss) so you will likely owe a tax. The $150,000 you could not deduct in 2018 is called an excess business loss, treated as a net operating loss carryover to 2019 (subject to the new NOL rules to be covered in our next alert).


The excess business loss rules are effective in 2018 and expire after 2025. If you have any questions on how these limitations will affect your tax liability, please contact your LMC professional.

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