By Ryan Hodell, CPA
Staff, Tax Services
Each Thursday for the next few weeks, Sponsel CPA Group will present The Deep Dive, a closer look at individual aspects of the new tax law and how they might affect you or your business.
The Tax Cuts and Jobs Act made some modifications to the way taxpayers can utilize losses, implementing new limitations that may catch some taxpayers. Net Operating Losses (NOLs) can no longer be carried back, with a couple exceptions. And a new disallowance of “excess business losses” could limit how much is deducted in the year trade and business losses occur, resulting in NOL treatment for any disallowed portion.
The new law has repealed the two-year and special carryback provisions for NOLs that first occur in tax years ending after December 31, 2017. The exception is that there are still provisions for two-year carrybacks on certain farming losses and NOLs for property and casualty insurance companies. All other NOLs occurring after this date must be carried forward.
The new law also modified how the NOLs can be used in future years. Instead of being limited to carrying the loss forward for 20 years, most NOLs occurring after the effective date are now carried forward indefinitely. However, these NOLs can only offset up to 80% of taxable income, calculated prior to deducting any NOL. If an NOL is limited under these provisions, the remainder will continue to carry forward.
Example of the 80% Limitation: In 2018, a calendar-year taxpayer has a $90,000 NOL. It has no other NOL carryovers. It carries forward the NOL to 2019, a year in which it has taxable income of $100,000. The taxpayer’s 2019 NOL deduction is limited to $80,000 ($100,000 x 80%). The remaining $10,000 can’t be deducted in 2019, but it can be carried forward indefinitely.
To further complicate matters, any NOLs that first occurred in 2017 or earlier will continue to follow the old rules. They will not be subject to the 80% limitation. This creates a need for separate record keeping of NOLs for these different periods.
New Limitations on Excess Business Losses
Under pre-Tax Cuts and Jobs Act law, a taxpayer’s farm loss could be limited to a given threshold if they received an applicable subsidy in that year. This was known as “excess farm losses.” The new law eliminates this provision for farm losses and instead disallows a taxpayer’s “excess business loss.”
For tax years beginning after December 31, 2017 and before January 1, 2026, non-corporate taxpayers can’t deduct excess business losses. Taxpayers must look at their aggregate trade and business losses to determine if there is any excess that will be disallowed. If these losses exceed $500,000 for married filing joint (and $250,000 for single), then any excess is disallowed and converted to an NOL to be carried to future years. Although the new provision states this is for non-corporate taxpayers, further language clarifies that this includes losses from S corporations and partnerships.
Example: If a taxpayer had $400,000 in losses flowing to their return from an S corporation, and their spouse had $200,000 of losses from a sole proprietorship, then they would add these together for $600,000 in combined business losses. The combined loss is then subtracted from the threshold amount ($500,000 – MFJ), and the $100,000 in excess business losses would be converted to an NOL that would carry forward to future years. Since this is now an NOL, it would also be subject to the new 80% NOL limitation in future years that was discussed above.
In effect, the new law limits the ability of non-corporate taxpayers to use trade or business losses against other sources of income, such as wages and other compensation, fees, interest, dividends and capital gains. The result is that the business losses of non-corporate taxpayers for a tax year can offset no more than $500,000 (MFJ), or $250,000 (other individuals), of a taxpayer’s non-business income for that year.
Both of these new provisions make excess losses less valuable because they can no longer eliminate all of the taxable income in a given year. They also can’t provide immediate benefit by being able to carry them back to a prior tax year. This can make it even more important to manage the usage of other deductions now available to taxpayers, such as accelerated depreciation expensing provisions, to ensure maximization and timing of deductions.
Sponsel CPA Group is here to help you manage these complex provisions and maximize your benefits. If you have questions about tax reform changes, please call Ryan Hodell at (317) 613-7868 or email RHodell@sponselcpagroup.com.
Click here for detailed article on “Business Expense Deduction Limitations”
Click here for detailed article on the “Pass-Through Income Deduction”
Click here for detailed article on “Changes to Fringe Benefit Rules for Employers”
Click here for detailed article on “New Favorable Depreciation Provisions”
Click here for summary of “Key Provisions Affecting Individual Taxpayers”
Click here for summary of “Key Provisions Affecting Business Taxpayers”