Under the Tax Cuts & Jobs Act (TCJA), the excess farm loss limitation now does not apply and is replaced with a provision that “excess business losses” are not allowed to be deducted in the current year against other sources of income. “Excess business losses” are defined as the excess of business deductions over the sum of business income plus $250,000 for a single taxpayer or $500,000 for a joint return. For example, if a married taxpayer had a net business loss of $600,000, only $500,000 of the $600,000 loss can be deducted against other sources of income in the current year and the remaining $100,000 must be carried forward. The $100,000 loss will be carried forward as part of the individual’s net operating loss (NOL) carryforwards. For more on NOLs, read last week’s article on the new NOL rules.
This new provision will affect taxpayers who have income from partnerships, sole proprietorships, and S corporations. The calculation of “excess business losses” happens at the partner or shareholder level. The new provision institutes the limitation for tax years beginning after December 31, 2017 and before January 1, 2026 and will be adjusted for inflation during those years.
Taxpayers with significant income from wages, retirement and investment income while incurring significant losses from active business will potentially pay higher tax as a result of this change in the tax law. Planning to minimize the effect of this new provision will require planning well in advance of year end, and may be difficult to achieve.
Passive loss limitations (losses from businesses in which you do not materially participate, like rental real estate or other businesses in which you don’t regularly, continuously, or substantially participate) will continue to be limited to the amount of passive gains.