Understanding Excess Business Losses for Non-Corporate Taxpayers: CARES Act and Beyond

The taxation landscape is constantly evolving, and one significant change introduced by the CARES Act is the limitation on *excess business losses for non-corporate taxpayers*. This provision primarily impacts shareholders and partners of pass-through businesses and sole proprietors. Initially effective from January 1, 2021, to January 1, 2026, this limitation prevented taxpayers from using business losses to offset their non-business income excessively. However, it was recently extended to January 1, 2029, as part of the Inflation Reduction Act.

What is an excess business loss?

An "excess business loss" happens when a person's business expenses exceed the income they earn from their business activities. For 2023, the amount is $289,000 ($578,000 for joint return filers). For tax years beginning after December 31, 2017, the excess is determined without regard to any deductions, gross income, or gains attributable to any trade or business performing services as an employee. Example: One of our clients has a full-time position and earns 1 million dollars on W2. His wife and he also had multiple rental properties that had a loss at the end of the year. The client could deduct up to $578,00 when filing his joint tax return.

What business does this rule apply to?

This rule applies to various types of businesses, such as farming (like what you'd find on Schedule F), self-employment (like gigs reported on Schedule C), rental activities (reported on Form 8825), and other business activities listed on Schedule E. It also includes any profits or losses reported on Forms 4797 and 8949 and income or losses from partnerships and similar setups.

What are the conditions before applying this rule?

Before this rule can be applied, taxpayers must follow specific other tax rules, such as the "at-risk rules" and "passive activity loss rules." These rules help make sure that the losses are genuine and not being manipulated for tax benefits. Our team can walk you through these rules to ensure you comply.

How does this affect your taxes?

If you have an excess business loss, it's added back to your income when you file your personal income taxes. This means it can reduce the loss you claim from your business activities on your tax return.

What happens to excess business losses in the next year?

Due to these rules, it doesn't go to waste if you can't use the excess business loss in one year. You carry it forward to the next year as a "net operating loss" (NOL). This NOL can be used to reduce your taxes in the following years, but there are limits on how much you can use, especially if it arose after 2017. Partnerships, S corporations, and fiduciaries apply the excess business loss rules at the shareholder level.

Are there limits on Net Operating Loss (NOL)?

Yes, there are some limits. If your NOL arises after 2020, you can carry it forward indefinitely, meaning there's no time limit. However, if it's from a year after 2017, you can only use it to offset up to 80% of your taxable income in a given year. There's also no going back in time (no "carryback") unless you're dealing with certain special cases, like farming losses or non-life insurance company losses.

Understanding the changing regulations and the impact these regulations have on your taxes is critical. Talk to our tax experts now to ensure you have the correct deductions in place for the upcoming tax season.