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Mid-Year Warning on Deducting Business Losses

The Tax Reform Act signed into law by President Trump contained many favorable tax provisions for business owners.

It contained a few surprises, too. None bigger, perhaps, than the new rules disallowing the deduction for excess business losses.


The New Business Loss Suspension Rule

Prior to 2018, the last major Tax Reform Act passed in 1986 introduced the concept of limiting and suspending Passive Activity Losses (PAL). With a few exceptions, losses from the rental of real estate or from a business activity you were not very involved in were not currently deductible. Instead, those losses were suspended until the activity either generated a profit or was sold.

It took some getting used to, but 31 years later the concept of PAL is generally well-known and the management of those accumulated PALs is an ongoing planning adventure.

The Tax Reform Act passed in December 2017, and in effect for 2018 extends the PAL concept in two new ways. Neither of these two new rules are going to make anyone happy, and is likely to generate shock and surprise for those who are not prepared.
Excess Business Losses

In addition to the PAL rules, business owners will now have to consider if they are subject to the excess business loss rules. This new rule goes into effect in 2018 and through 2025.

An excess business loss will be the excess of your aggregate business losses over $250,000 ($500,000 if you are a married joint-filer). The nondeductible excess business loss will be carried over to the following tax year and can be deducted under the rules for net operating losses (see below).
New Rules for Deducting Net Operating Losses (NOLs)

Prior to 2018, NOLs could generally be carried back to the two preceding tax years to recover income taxes paid in those earlier years. Like making lemonade from lemons, the loss carryback could sometimes generate a sizable refund right when the taxpayer needed it the most.

Starting in 2018, that refund opportunity no longer exists. NOLs must now be carried forward to be used as a loss to offset taxable income in 2019 or a future year. As a further limitation, the NOL carryover will offset no more than 80% of the taxable income in the carryover year, which means you will no longer be able to use an NOL to totally wipe out all tax obligations in a carryover year.

These new rules could have a dramatic impact on start-up and nascent enterprises. In the past, emerging business owners could use those losses to offset their other taxable income (perhaps W-2 wage income) and use the tax savings to help capitalize their businesses. That form of alternative business financing is now off the table.

Be sure to let us know if you have questions or need assistance in determining the potential impact of these new rules on your personal income tax situation.

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