Excess business loss limitation developments

The excess business loss (EBL) limitation is here to stay — at least through the 2028 tax year. The provision, codified in Internal Revenue Code section 461(l), limits the amount of trade or business losses noncorporate taxpayers can utilize to offset nonbusiness income. The EBL limitation took effect in the 2021 tax year and, due to the Inflation Reduction Act (IRA), will remain in effect for a minimum of eight years. Taxpayers who own pass-through entities, which include sole practitioners and their advisors, must understand and incorporate the EBL limitation into annual tax compliance and planning.

Excess business loss limitation history

In recent years, the EBL limitation has been on an implementation roller-coaster. First introduced as part of the Tax Cuts and Jobs Act (TCJA), the provision was originally effective for tax years 2018 through 2025. However, in response to significant pandemic-induced economic uncertainty and market declines, the Coronavirus Aid, Relief and Economic Security (CARES) Act retroactively delayed the provision’s implementation to 2021. This provided taxpayers who had already filed 2018 and 2019 returns incorporating the EBL limitation an opportunity to amend returns, fully claiming business losses.

After the CARES Act, two additional pieces of legislation changed the effective dates of the EBL limitation. The American Rescue Plan Act (ARPA) and, more recently, the IRA extended the EBL limitation for one and two additional years, respectively. Ultimately, this means the provision will be in effect for a minimum of eight tax years — 2021 through 2028.

Applying the excess business loss limitation

EBLs are calculated by determining the amount by which a taxpayer’s aggregate trade or business deductions or losses exceed their gross trade or business income or gain. The ability to deduct the losses, to the extent they exceed income, is limited to an annual threshold amount indexed for inflation. In 2021, the threshold was $262,000 for most taxpayers ($524,000 for joint filers). In 2022 and 2023, the amounts increased to $270,000 ($540,000 for joint filers) and $289,000 ($578,000 for joint filers), respectively.

The limitation is applied at the pass-through entity owner level for reporting on their individual income tax returns. The limitation applies after the outside basis, at-risk, and passive activity loss limitations. Net trade or business losses that exceed the annual threshold amount are carried forward as a net operating loss (NOL) which the taxpayer may use to offset taxable in a subsequent tax year, subject to NOL rules.