The Tax Cuts and Jobs Act (TCJA) tax reform added an amazing limit on larger business losses that can attack you where it hurts—right in your cash flow.
And this new law works in some unusual ways that can tax you even when you have no real income for the year. When you know how this ugly new rule works, you have some planning opportunities to dodge the problem.
Over the years, lawmakers have implemented rules that limit your ability to use your business or rental losses against other income sources.
The big three are:
The TCJA tax reform added Section 461(l) to the tax code, and it applies to individuals (not corporations) for tax years 2018 through 2025.
The big picture under this new provision: You can’t use the portion of your business losses deemed by the new law to be an “excess business loss” in the current year. Instead, you’ll treat the excess business loss as if it were a net operating loss (NOL) carryover to the next taxable year.
To determine your excess business loss, follow these three steps:
Example. Paul invested $850,000 in a start-up business in 2018 and the business passed through a $750,000 loss to Paul. He has sufficient basis to use the entire loss, and it is not a passive activity.
Paul’s wife had 2018 wages of $50,000, and they had other 2018 non-business income of $600,000.
Under prior law, Paul’s loss would offset all other income on the tax return and they’d owe no federal income tax.
Under the TCJA tax reform that applies to years 2018 through 2025 (assuming the wages are trade or business income):
To avoid this ugly rule, you’ll need to keep your overall business loss to no more than $250,000 (or $500,000 joint). Your two big-picture strategies to make this happen are:
If one of your businesses will have a loss in excess of the limits, we should start discussing planning opportunities as soon as possible. The longer we wait, the fewer opportunities we will have to limit or, better yet, eliminate the damage. Please do not hesitate to reach out to your team at Luster Tax Consulting to work through this with you. Please use the following link to book your complimentary strategy call with your team at Luster Tax Consulting.
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