As we detailed in our January 2018 tax alert, the Tax Cuts and Jobs Act (TCJA or the Act) modified the use of net operating losses for most taxpayers. The Act also imposes limitations on noncorporate business losses, somewhat similar to the passive loss rules enacted in 1986. While these new rules are in effect beginning in 2018, there are multiple implementation questions for which further guidance is pending. We will briefly summarize the new rules then highlight some planning ideas.
Net operating losses
Net operating losses (NOLs) arising in tax years beginning after Dec. 31, 2017, can only offset 80 percent of taxable income (without regard to the new section 199A deduction). NOL carrybacks are no longer permitted, meaning future losses cannot be monetized by filing refund claims. While carrybacks are not allowed going forward, there is now an unlimited carryover. Fiscal-year taxpayers with NOLs arising in tax years beginning before Dec. 31, 2017, and ending after Dec. 31, 2017, are not subject to the 80 percent limitation but are not eligible for a carryback either. Since carryforwards may only offset 80 percent of taxable income, corporations will effectively pay a 4.2 percent tax rate in a profitable tax year. Historic limitations remain on acquired NOLs as well as when ownership changes in loss corporations take place.
Noncorporate business losses
For the first time, business losses of noncorporate taxpayers are limited. Individuals are no longer allowed to reduce nonbusiness income (such as interest, dividends and capital gains) with business losses beyond a threshold in tax years between 2018 and 2025. Up to $500,000 (on a married filing joint return) of losses can offset a taxpayer’s other sources of income. Nondeductible or surplus amounts are referred to as excess business losses and can be carried forward indefinitely. These excess business losses basically become NOL carryforwards and are subject to the 80 percent limit referred to above. This business loss imitation is applied at the individual partner or shareholder level and are applied after passive loss rules.
While Treasury has been busy issuing guidance on a multitude of TCJA-related changes (including the section 199A pass-through deduction, section 179 and bonus rules, and international changes), we are still awaiting input on these loss rules. In the meantime, we offer the following tips when assessing how these new rules affect your business activity.
- Consider carefully when to use bonus depreciation and section 179 expensing. Since NOLs are now limited in their carryforward amount, it may be prudent to preserve depreciation deductions for future years.
- The new 80 percent limitation on carryforwards on top of the historic loss limitations may make the acquisition of NOL companies less valuable. Acquisition pricing may need reassessing in certain deals. You should also keep in mind that historic rules that can also limit the use of “purchased” NOLs remain unchanged by the TCJA.
- As individual taxpayers are now limited in how much nonbusiness income can be sheltered with business losses, careful planning should take place between now and year-end to project the amount of any 2018 tax liability.
- While the passive loss limitations apply before the excess business loss rules, it remains unclear whether passive activity income and losses are included in the determination of the excess business loss.
- Taxpayers generating business losses via multiple pass-through entities may have to apportion or allocate a piece of each entity’s loss up to the threshold. Guidance is needed in order to determine how these amounts should be allocated and tracked.
- If spouses have separate trades or business reported on a joint return, the presumption is the excess business loss limitation applies to the combined income and deductions from all of the trades or businesses.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.