Many taxpayers were hit with an unwelcome surprise when Section 461(l) entered the U.S. tax code as part of the Tax Cuts and Jobs Act of 2017. Effective for years beginning after Dec. 31, 2017, the main effect of Section 461(l) is that it limits the use of excess business losses for noncorporate taxpayers. In short, 461(l) means individuals — including those who are considered pass-through entities for tax purposes — may only deduct up to $250,000 (or $500,000, for joint filers) in business losses against their nonbusiness income on their tax returns. Losses in excess of the threshold are carried forward as a net operating loss to the following tax year.
The provision has primarily affected high-net-worth individuals, many of whom own side or hobby or startup businesses that generate losses. In the past, these individuals could apply these losses against income from employment, capital gains, interest and other non-business income sources to considerably reduce their taxable income and hence lesson their overall tax burden. 461(l) put limits on that strategy.
All that has changed again, however, in the wake of the 2020 coronavirus pandemic. As part of the Coronavirus Aid, Relief and Economic Security (CARES) Act designed to stimulate the economy into recovery mode, Congress agreed to suspend the 461(l) limitation not just for tax year 2020, but also retroactively for 2018 and 2019. That means taxpayers who filed 2018 or 2019 returns and were limited by their net operating losses may be eligible to amend and request a refund for significant amounts.
Looking forward, a number of tax planning strategies may emerge from these developments, depending on the individual’s particular circumstances. For instance, suppose your loss-generating business is intending to make large capital purchases in the near future. It may be more advantageous from a tax standpoint to bunch as many anticipated expenses, such as that large capital purchase, into 2020 as possible. That is because any business losses recognized 2020 will again be subject to the 461(l) limitation.
Likewise, individuals may want to take advantage of any opportunities to defer business income to 2021 in order to maximize their losses this year while the suspension of the limitation is still in place. Accelerating business deductions where possible such that they can be recorded on their 2020 tax returns would also help individuals take advantage of this incentive by increasing the size of their business’s losses.
These are just several of the myriad ways in which individuals may be able to make use of the suspension. What readers should take away is this is a major boon to individuals with nonbusiness income who have experienced (or expect to see) business losses over the past three years. But to take advantage of this opportunity, you must contact your CPA as soon as possible, or else it could be too late.
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The CPAs in BPM’s Private Client Services group are standing by to assist clients as the window of opportunity for making use of this development quickly closes. With a body of seasoned tax professionals who utilize all the tools available to increase your savings, our Private Client Services group is fully equipped to produce the ideal tax planning strategy for your unique situation. To learn more, contact Ronald Maestas at [email protected].
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