The Tax Cuts and Jobs Act of 2017 (TCJA) added the excess business loss (EBL) limitation under sec 461(l) applicable to noncorporate taxpayers,  in addition to the already existing limitations of basis, at-risk and passive activity loss rules,  effective for taxable years beginning after December 31, 2017 and before January 1, 2026.

However, it was suspended for tax years 2018, 2019 and 2020 under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 in response to the pandemic to provide the much-needed economic relief to taxpayers. Accordingly, if taxpayers had already filed their 2018 and/or 2019 returns with the limitation, then they could file amended returns to deduct those losses and potentially generate a refund as applicable.

Because American Rescue Plan Act of 2021 further extended the application of sec 461(l) excess business loss limitation for one year, it now applies to tax years beginning after December 31, 2020 and before January 1, 2027.

The EBL is the amount by which the aggregate deductions for the taxable year from all of the taxpayer’s trades or business exceed the sum of aggregate income and gain from those trades or businesses, plus the threshold amount. The threshold amount is adjusted annually for inflation and the amount for tax year 2021 is $262,000 (or $524,000 for married filing joint return).

Any disallowed loss becomes a net operating loss (NOL) carried over to the next tax year. The EBL limitation is applied after applying the limitations under the tax basis, at-risk and passive activity loss rules in that order. The EBL limitation from partnerships and S corporations is applied at the partner/shareholder level.

The CARES Act provided the following technical corrections and clarifications pertaining to the computation of EBL:

• Any allowable deduction under sec 172 (NOL) or sec 199A (Qualified Business Income Deduction) are excluded from aggregate deductions in the computation of EBL
• Deductions for any losses from sales or exchanges of capital assets are excluded from aggregate deductions in the computation of EBL
• Any deductions, gross income or gains attributable to the performance of services as an employee are excluded from aggregate gross income or gains in the computation of EBL. Accordingly, wages will not be considered business income and will be excluded in the computation of EBL limitation.
• The amount of gain to be included in aggregate gross income and gain is the lesser of net capital gains attributable to sale or exchange of assets used in trade or business or overall capital gain net income.

For example:

A married couple filing jointly have income from W-2 wages of $250,000, interest and dividend income of $350,000 and loss of $750,000 from a partnership in which they have sufficient basis, are at-risk and have material participation. W-2 wages will not factor into the computation and accordingly the excess business loss will be $226,000 ($750,000 net business loss - $524,000 threshold = $226,000 EBL). The net taxable income will be $76,000 ($250,000 W-2 Wages + $350,000 interest and dividend - $524,000 Deductible Business Loss).

It is important to note that although, the CARES Act suspended the implementation of sec 461(l) until tax year 2021 for federal income tax purposes, since New York (NY) decoupled from the CARES Act, the EBL limitation was in effect for NY income tax purposes for tax years 2018- 2020. This added to the complexity in tracking the different buckets of carryover losses for federal and NY income tax purposes separately.

Possible changes to sec 461(l) in the Build Back Better Plan:

The House of Representatives approved the Build Back Better Act (H.R. 5376) reconciliation bill on November 19, 2021. It includes the provision which makes the limitation on excess business loss under sec 461(l) permanent effective for tax years beginning after December 31, 2020. The disallowed losses can be carried forward, however, with certain modifications. Originally, the disallowed losses would be treated as NOL and carried forward to the next year. However, under the provisions of H.R. 5376, these will be carried over as a separate category of Sec 461(l) losses and not as NOL. As a result, the carryover EBL will be subject to testing again in the following year under the same limitation rules, thereby prolonging the utilization of these losses. There are several other issues and concerns such as uncertainty due to changes becoming applicable retroactively to tax years beginning after December 31, 2020, and permanent loss of EBL remaining at the taxpayer’s death if not addressed by the Senate.

However, the bill is currently stalled in the Senate, and expected to go through several revisions and be scaled down before it is taken up for voting anytime soon. Tax professionals should be following the bill closely as it moves through the process to guide their clients through its current and future impact on their tax obligations.

Shashi Singal, CPA, MSA, CA, is a partner at Grassi and brings over 20 years of diversified tax and accounting experience to the firm. Her expertise lies in review of tax returns, research projects, tax planning and projections, international tax planning and compliance, assisting with mergers, acquisitions, and corporate re-structuring. Shashi works with clients primarily in the manufacturing & distribution, wholesale and retail industries, law firms, architecture and engineering firms, real estate companies, family partnerships and private foundations. Prior to joining Grassi, Shashi worked at a regional firm for nine years and was part of their senior staff. In her role, Shashi was responsible for planning and managing audits, reviews and compilations, preparation and review of tax returns, tax projections, financial statements and budgets for a wide variety of clients, including ERISA benefit plans. Outside of her role as partner, Shashi is very engaged within the firm, authoring articles on emerging tax topics published in the NYSSCPA’s Tax Stringer and other professional journals and newsletters.  She has lent her expertise to panel discussions on various tax topics including at the NYSSCPA’s 2019 Qualified Opportunity Zones Symposium, presented seminars for Accountants World and internal staff training. She has been recognized as one of 2021 Women in Commercial Real Estate by New York Real Estate Journal. She also participates in the firm’s mentor program, assisting up-and-coming staff members and helping them navigate issues related to both accounting and career development. Shashi is a member of the AICPA, NYSSCPA and the Institute of Chartered Accountants of India (ICAI). Shashi holds a Masters in Accounting degree from Queens College. She is fluent in Hindi, Gujarati and Marathi (Indian regional languages).