Excess business loss limitation effective for 2021

The excess business loss (EBL) limitation, codified in Internal Revenue Code section 461(l), was originally created by the Tax Cuts and Jobs Act of 2017 (TCJA). Appling to taxpayers other than corporations, this provision limits the amount of trade or business deductions that can offset nonbusiness income. The limitation for the 2018 tax year was $250,000 (or $500,000 in the case of a joint return), with these threshold amounts indexed for inflation in subsequent years.

Section 461(l) went into effect for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, making 2018 through 2025 filings subject to the limitation. However, the Coronavirus Aid, Relief, and Economic Security (CARES) Act retroactively delayed the implementation of section 461(l) from tax years beginning after Dec. 31, 2017, to tax years beginning after Dec. 31, 2020. Taxpayers who had already filed 2018 or 2019 returns with the EBL limitation, received an opportunity to amend returns, fully claiming business losses.

As 2021 comes to a close, remember, the EBL limitation is now in effect and should be incorporated into annual tax planning going forward (through 2025). For the current year, the indexed limitation amount is $262,000 (or $524,000 in the case of a joint return). Net business losses in excess of this amount will be disallowed on 2021 return filings and carried forward.

Applying the excess business loss limit

 EBLs are defined as the excess of a taxpayer’s aggregate trade or business deductions (determined without regard to the limitation of the provision), over the sum of the taxpayer’s aggregate gross trade or business income or gain, plus the threshold amount (as described above).

The limit is applied at the partner or S corporation shareholder level and calculated after application of the passive activity loss and at-risk limitations. Net trade or business losses that exceed the threshold amount are carried forward as part of the taxpayers’ net operating loss (NOL) carryforward to subsequent taxable years. (See our article on expiring provisions for a discussion of NOL treatment.)

To illustrate, consider a taxpayer that is a sole proprietor, whose trade or business deductions in 2021 totaled $1 million. The taxpayer’s gross receipts from the business and dividend income from their brokerage account each totaled $500,000. The taxpayer’s 2021 EBL is $238,000 (the taxpayer’s $1 million trade or business deductions, minus the sum of their $500,000 of trade or business income and the $262,000 threshold amount for 2021). As a result, even though the taxpayer’s total gross income and deductions net to $0, the taxpayer’s 2021 taxable income after the application of section 461(l) is $262,000. The $238,000 EBL carries forward to 2022.