Temporary repeal of excess business loss limitation triggers need to amend returns

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), providing a measure of relief to businesses and individual taxpayers affected by economic fallout from the Coronavirus. Among its myriad provisions, the CARES Act repeals Section 461(l), the limitation on non-corporate taxpayer excess business losses for taxable years beginning after December 31, 2017 through December 31, 2020 by retroactively deferring the effective date until taxable years beginning after December 31, 2020. Additionally, the bill provides several technical corrections to Section 461(l).

Originally introduced as part of the Tax Cuts and Jobs Act of 2017, Section 461(l) denies noncorporate taxpayers a deduction for “excess business losses” (defined as the excess of trade or business deductions over trade or business gross income or gains) in excess of a certain threshold.  The allowable loss is limited to the excess of $250,000 for single filers or $500,000 for joint filers, with any disallowance carried forward to future years. In other words, under Section 461(l), individuals and trusts with business losses derived from sole proprietorships, partnerships, or S-Corporations can only offset non-business income such as wages and investment income with business losses up to the threshold.

With the temporary repeal of Section 461(l), taxpayers subject to limitation in 2018 (and 2019 if a return was already filed) should strongly consider amending returns to claim a refund. Importantly, the repeal of Section 461(l) is not elective. As a consequence, if a taxpayer subject to limitation does not amend, the IRS could adjust downward the amount of a taxpayer’s loss carryforward. If the taxpayer’s statute of limitation for the relevant year (i.e., 2018 or 2019) is closed at the time of the adjustment, then the taxpayer would lose the relevant benefit.

The temporary repeal may be particularly significant to owners of, and investors in, real estate.  To the extent real estate activities generated losses subject to 461(l) limitation in 2018, the filed tax returns for that year should be amended or at least reviewed to determine the temporary repeal’s impact.

Owners of real estate should also consider the impact of other changes resulting from the passage of the CARES Act.  For example, modifications to the deductibility of interest under 163(j) or accelerated depreciation resulting from the correction to the rules involving qualified improvement property (QIP) may dovetail with the temporary repeal of 461(l) requiring additional scrutiny of previously filed 2018 tax returns.

Given that the future use of excess losses may potentially be at stake, at least to the extent the losses could have been utilized in 2018/2019, the importance of filing an amended return cannot be understated. Undertaking to file an amended return will not only provide the taxpayer with a potential refund (a timing issue), but perhaps more significantly preserves the loss (a quantitative issue).  A taxpayer should also consider whether losses freed as a result of the Section 461(l) repeal are suitable for carryback under the bill’s new net operating loss provisions.

Upon the reintroduction of section 461(l) beginning in the 2021 tax year, the CARES Act has provided several technical corrections that should be noted.

  • Excess business losses are computed without regard to net operating loss deductions under Section 172 and qualified business income deductions under Section 199A.
  • W-2 income will not be considered trade or business income for purposes of the excess loss limitation, and therefore may only be offset to the extent of the threshold. This change is likely to see a substantial increase in the number of taxpayers impacted by Section 461(l).
  • Losses from the sale of capital assets are only included in the Section 461(l) computation to the extent relevant for determining trade or business capital gain which is includable as the lesser of: (1) net capital gain from only trade or business capital gain or loss; or (2) net capital gain.

Please consult your Mazars USA LLP professional for additional information.

Published on April 8, 2020

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.