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Suspension of Excess Business Loss Limitation for Tax Years 2018-2020 Presents Opportunities and Issues

5.8.20 | Client Alert – COVID-19 Update

The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily suspends Internal Revenue Code (IRC) Section 461 business loss limitations for tax years 2018-2020. Prior to this temporary repeal, under the Tax Cuts and Jobs Act (TCJA), net business losses for taxpayers, other than corporations, were limited to $500,000 for married taxpayers filing jointly and $250,000 for all other taxpayers, curtailing the ability to use these losses to offset non-business income. The limitation amounts were indexed for inflation each year. The disallowed excess business losses (EBL) were then treated as a Net Operating Loss (NOL) for the taxable year for purposes of determining any NOL carryover to the succeeding tax year. This limitation applied after at-risk and passive activity loss limitations.

The retroactive repeal of Section 461 to 2018 creates an opportunity for affected taxpayers to amend their 2018 income tax returns to eliminate the effect of the EBL limitation. Taxpayers that generated an EBL in 2018 had significant nonbusiness taxable income, such as interest, dividends or portfolio capital gains will want to act. Ultimately, the amended 2018 tax return may result in a refund of tax and a decrease in the 2018 NOL carry forward.

If after amending the 2018 tax return, a 2018 NOL is generated, the taxpayer has the choice to either carryback the 2018 NOL to tax year 2013 and subsequent years or elect to forgo the carryback and carryforward the NOL to 2019 and later. The determination between carrying back or carrying forward a 2018 NOL requires a consideration of the taxpayer’s prior five years of income, as well as income for 2019 and beyond. In either case, taxpayers should be aware of the repeal of the EBL rules impact on their 2019 income tax calculations, whether due to 2018 or 2019 EBLs that are no longer limited.

Carryback vs. Carryfoward

If a taxpayer chooses to carryback the NOL to 2013 and subsequent years, the taxpayer can file an application for a tentative carryback adjustment (Form 1045) or file an amended tax return for each carryback year the NOL applies to. For a detailed summary of the advantages and disadvantages of the short form application and amended tax return, click here.

On the other hand, if a taxpayer decides to carryforward the 2018 NOL, the taxpayer must elect to waive the carryback of NOLs on their 2020 tax return. For a detailed explanation of how to waive the carryback of NOLs for 2018 and 2019 tax years, click here.

The CARES Act also provided technical corrections to the net business loss limitation as it applies to tax years beginning after 2020. Wages and related deductions and gains attributable to any trade or business of performing services as an employee will NOT count as business income. Business losses do not include losses from capital assets, unless such capital assets are used in a trade or business. Business capital gains are included in the computation of business losses, but are limited to the lesser of business capital gain net income (determined by taking into account only gains and losses attributable to trades or businesses), or overall capital gain net income.

The limitation on excess business loss impacted a significant number of taxpayers in 2018. The retroactive suspension of this limitation, along with the interplay with the NOL rules, creates an elevated level of complexity when assessing each taxpayer’s situation. Moreover, with the 2019 income tax return filing deadline of July 15, 2020 approaching, affected taxpayers have limited time to amend their 2018 income tax returns to calculate the correct amount of 2018 NOL carryforward to 2019.

For more information on this topic or any other matter related to the COVID-19 pandemic, please contact your Berdon Advisor.

Berdon LLP New York Accountants