Loss Cause: Developments in the Section 461(l) Excess Business Loss Rule as of Fall 2022

Forthcoming as Chapter 134 of The Partnership Tax Practice Series: Planning for Domestic and Foreign Partnerships, LLCs, Joint Ventures & Other Strategic Alliances 2023 (Louis S. Freeman & Clifford M. Warren eds., Practicing Law Institute)

27 Pages Posted: 26 Apr 2021 Last revised: 22 Nov 2022

Date Written: November 21, 2022

Abstract

This is a follow-up to a 2019 article entitled The Curious Case of Section 461(l): Why This Unclear and Unwise New Rule Should Be Construed as Narrowly as Possible. That article offered an analysis of section 461(l)’s excess-business-loss limitation rule as originally enacted in 2017 as part of the Tax Cuts and Jobs Act. It explained how the excess-business-loss limitation contravenes fundamental notions of what an income tax is, and how the rule threatens to inflict significant harms on small businesses. The article therefore argued for section 461(l)’s repeal.

This update, which is current as of November 21, 2022, discusses developments that have occurred with respect to section 461(l) since the earlier article was published.

This article describes amendments to section 461(l) that were enacted as parts of (1) the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020, (2) the American Rescue Plan Act of 2021 (ARPA), and (3) the Inflation Reduction Act of 2022 (IRA). Under the CARES Act, Congress temporarily suspended the excess-business-loss rule for 2018, 2019, and 2020. However, in ARPA and the IRA, Congress subsequently extended the rule’s effective period twice—by a total of three years. As of the time of this writing, section 461(l) is effective for taxable years beginning after December 31, 2020 and before January 1, 2029.

The CARES Act amendments also resolved several ambiguities in section 461(l)’s original language. Unfortunately, as this article explains, at least a couple of those “clarifying” amendments exacerbate section 461(l)’s onerous effects on taxpayers. One of those amendments, for example, reclassifies a taxpayer’s wage or salary income as nonbusiness income for purposes of the provision. This change considerably expands the reach of the excess-business-loss rule. Another CARES Act amendment curiously adds a taxpayer’s nonbusiness capital losses into the calculation of her deemed trade-or-business income (or loss) in certain cases. In some such cases, the nondeductible portion of the taxpayer’s business-related loss is increased as a result.

This article also discusses potential additional amendments to section 461(l), which some members of Congress have proposed but which have not yet been enacted. Those proposed amendments include (1) retroactively reinstating section 461(l) for 2018, 2019, and 2020, (2) removing the rule’s sunset provision and making section 461(l) permanent, and (3) subjecting disallowed “excess” losses in one year to the same loss limitation again in subsequent years. If those proposed amendments were ever to take effect, the harms caused by the excess-business-loss rule would be amplified even further, and those harms would become perpetual.

This update examines all of these points, and the issues that they raise for both policymakers and practitioners, in detail.

Forthcoming as Chapter 134 of The Partnership Tax Practice Series: Planning for Domestic and Foreign Partnerships, LLCs, Joint Ventures & Other Strategic Alliances 2023 (Louis S. Freeman & Clifford M. Warren eds., Practicing Law Institute).

Copyright © 2021, 2022 by Steven Z. Hodaszy

Keywords: section 461(l), excess business loss, pass-through taxation, depreciation

Suggested Citation

Hodaszy, Steven Z., Loss Cause: Developments in the Section 461(l) Excess Business Loss Rule as of Fall 2022 (November 21, 2022). Forthcoming as Chapter 134 of The Partnership Tax Practice Series: Planning for Domestic and Foreign Partnerships, LLCs, Joint Ventures & Other Strategic Alliances 2023 (Louis S. Freeman & Clifford M. Warren eds., Practicing Law Institute), Available at SSRN: https://ssrn.com/abstract=3834513 or http://dx.doi.org/10.2139/ssrn.3834513

Steven Z. Hodaszy (Contact Author)

Robert Morris University ( email )

6001 University Blvd.
Moon Township, PA 15108
United States

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