TCJA Hot Topics: Changes to Excess Business Loss and Net Operating Losses
Tax Principal Debbie Vandeven has more than 25 years of experience as an accounting professional with responsibility for tax planning and consulting services for individual and business clients. Here are a few of the business-related tax reform questions Debbie has been answering:
Q: How did the Tax Cuts and Jobs Act (TCJA) impact net operating losses for businesses?
A: To help offset the reduction in the corporate tax rate and pay for the qualified business income deduction, Congress decided to not only limit business interest, but also limit net operating losses (NOLs). Prior to the new tax legislation, NOLs could be deducted in full to offset current year income. They could also be carried back two years to generate refunds from years when you had paid taxes.
With the new tax law, NOLs generated in 2018 and later years can only be used to offset 80 percent of taxable income. This means that even in a year when NOLs are available in excess of current-year income, you would end up paying tax on 20 percent of your income, even though you still have a loss carryforward to the next year. Additionally, the two-year carryback period is no longer allowed. However, there is an indefinite carry forward period for NOLs now. Losses that arose prior to 2018 are not subject to the 80 percent limitation.
It’s important to note that the NOL limitation is calculated without regard to the qualified business income deduction.
Q: Are there any exceptions to these new limitations?
A: Yes, for property and casualty insurance companies and for farming losses. Neither of these industries is subject to the 80 percent limitation and you can still carry back those losses for two years. For property and casualty insurance companies, the carry forward period is limited to 20 years, like under prior tax law. Farming losses now have the indefinite carry forward period. Farming losses used to have a carryback period of five years, so these new rules are still less favorable than before.
Q: How are excess business losses impacted under the new tax law?
A: In a significant departure from prior law, the new tax law restricts the use of business losses for non-corporate taxpayers. Under prior law, as long as you had basis in your active trade or business, in general, you could deduct the loss without limitation. Under the new tax law, net business losses flowing through to individuals are limited to $500,000 for married taxpayers and $250,000 for all others. The losses are applied at the individual tax level. You need to aggregate all of your income or losses from all trade or business activities, and to the extent that they exceed $500,000 for married taxpayers, they’re going to be disallowed. Even if you have income from other sources, you cannot use it to offset this loss. These excess losses are then carried forward and become an NOL, which is subject to the aforementioned 80 percent limitation.