Extended Excess Business Loss Limitation: A Guide for Savvy Business and Property Owners
The excess business loss (EBL) limitation is here to stay, at least until the end of 2028. If you’re a business owner operating a pass-through entity, such as a short-term rental owner, it's crucial to understand this limitation and how it fits into your tax planning strategies for 2024 and beyond. Here’s everything you need to know to stay ahead.
Background on the EBL Limitation
The excess business loss limitation was introduced by the Tax Cuts and Jobs Act of 2017 (TCJA), amending §461 of the Internal Revenue Code. This change restricts the amount of business losses that noncorporate taxpayers can use to offset nonbusiness income. Since the 2021 tax year, tax liabilities have significantly increased for many business owners.
Initially set to expire in 2025, the EBL limitation has now been extended through 2028. As a result, owners of pass-through entities—such as sole proprietors, partners, and S Corporation shareholders—should work closely with tax professionals to integrate this restriction into their annual tax planning strategies.
How the EBL Limitation Works
The excess business loss limitation calculates the extent to which a taxpayer’s total business-related deductions exceed their total gross income and gains from business activities, plus an inflation-adjusted threshold. For the 2024 tax year, the thresholds are:
- $305,000 for single filers
- $610,000 for married couples filing jointly
The silver lining is that any business losses exceeding these thresholds aren’t lost; they’re carried forward as a net operating loss (NOL) to future tax periods. However, NOL deductions are capped at 80% of taxable income in subsequent years, potentially delaying full utilization for multiple tax periods.
For partnerships and S Corporations, the EBL limitation is applied at the individual partner or shareholder level but only after considering outside basis, at-risk, and passive activity loss limitations.
Exclusions and Special Considerations
When calculating excess business losses, there are important exclusions to keep in mind:
- Net Operating Losses (NOLs) and Qualified Business Income (QBI) deductions under IRC Section 199A are excluded.
- Losses from sales or exchanges of capital assets aren’t included in total business deductions.
- Wages earned as an employee do not count as part of the aggregate gross business income.
- Capital gains from business asset sales are limited to the lesser of:
- Net capital gain income
- Capital gain net income attributable to a business
Impact on Tax Planning
The EBL limitation highlights the importance of strategically timing business and nonbusiness income and expenses to maximize tax efficiency. Consider the following approaches:
- Evaluate Depreciation Deductions Carefully: Instead of taking full bonus depreciation, consider opting out of it on five-year or fifteen-year assets.
- Defer Taxable Income: If a significant excess business loss is unavoidable, deferring income into the next year may allow for quicker utilization of NOLs.
- Plan for Future Tax Rates: If you anticipate higher tax rates in the future, carrying forward NOLs to offset future income could provide more significant tax savings.
- Reassess Estimated Tax Payments: The EBL limitation can affect taxable income so that underestimating quarterly tax payments may lead to penalties and interest. Adjust estimated payments accordingly to avoid costly surprises.
Final Thoughts
With the EBL limitation extended through 2028, it's crucial for business owners to include this restriction in their tax planning proactively. Understanding how the limitation works and making strategic tax decisions can help minimize its impact on cash flow and overall tax liability. Consulting with a tax professional can provide invaluable guidance in navigating these complexities, ensuring you remain compliant while optimizing your financial standing