Another significant change made by the TCJA is the limitation on the deduction of business losses for taxpayers other than C corporations. New Internal Revenue Code (“IRC”) Section 461(l) provides that if the gross income and deductions of a taxpayer’s trade or business are aggregated, and if the net result is a loss, only $500,000 of that net operating loss (“NOL”) may be deducted in the current year on a joint return, or $250,000 for a single individual or a married taxpayer filing separately. The portion of the loss that is disallowed is carried forward to subsequent tax years as a net operating loss. The TCJA also limited the use of NOL deductions in subsequent tax years to offset 80% of a taxpayer’s taxable income.
In the case of partnerships and S corporations, the limitation is applied at the partner or shareholder level, and the partner or shareholder takes into account his share of business income and deductions from the partnership or S corporation along with any other gross income or deductions the taxpayer may have from other businesses. C corporations are not subject to this limitation.
In many cases, a taxpayer’s ability to deduct losses may already have been affected by the limitations on deducting passive losses and the business loss limitation will not impose any new limitations, although the new limitation may become applicable in the year the taxpayer disposes of the passive activity and any loss remaining from that activity after offsetting gains on the disposition becomes a nonpassive loss.
These limitations may be onerous for taxpayers who start new businesses that will have losses in the early years, especially where the taxpayer has significant income from other activities. The limitation will also apply to losses from real property holdings if the activity related to the real property is considered a trade or business. Like the other provisions of the TCJA that apply to individuals, the limitation on business losses will cease to apply after 2025.