Section 461(l) amendments may require taxpayers to amend 2018 returns
Included as part of the recently enacted Coronavirus Aid, Relief and Economic Security Act (the CARES Act or ‘the Act’) are various amendments, as well as technical corrections, to the statutory language of Section 461(I), commonly referred to as the excess business loss (EBL) limitation. Most notably, the Act retroactively eliminates the EBL limitation for tax years 2018 and 2019, and instead defers its effective date to tax years beginning after Dec. 31, 2020.
This amendment has important implications for 2019 filings.
For example, taxpayers that may have been facing an unfavorable EBL limitation for tax year 2019 will no longer be subject to that loss limitation. Tax returns for 2019 should not include an EBL limitation. The change may also have implications for 2020 estimate planning.
Second, net operating losses carrying into 2019 that originated with EBLs generated in 2018 must be recomputed prior to filing the 2019 tax return. Since the Act changed the effective date of the EBL limitation retroactively, section 461(l) no longer applies to tax year 2018. Accordingly, taxpayers that had an NOL carryforward in 2019 originating from a 2018 EBL will no longer have an NOL carryforward in 2019, at least with respect to the EBL.
Taxpayers will also need to amend 2018 returns.
Absent additional guidance, taxpayers in this position will need to amend their 2018 tax returns in order to claim the loss. If that loss creates an NOL in 2018, the Act requires that the loss be carried back, although taxpayers would still have the ability to waive that five-year carryback.
Aside from the change in effective date, the Act also includes two notable changes to the computation of EBLs once they reappear in 2021.
First, the Act includes a technical correction that provides that any excess business loss shall be “determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee.” Thus, W-2 wages are not business income for purposes of the excess business loss limitation.
Additionally, the Act includes a technical correction addressing the treatment of capital gains and losses. Specifically, net capital gains (but not losses) attributable to a trade or business are taken into account when computing an EBL, but they will be limited to the taxpayer’s overall capital gain net income. This change eliminates the ability of taxpayers to potentially convert capital losses into NOLs.
The technical changes to the computation of EBLs were widely anticipated. But the retroactive deferral until 2021 of the EBL limitation’s effective date will create some immediate issues for taxpayers and practitioners.
For many, the prospective and retroactive changes in the effective date of the excess business loss limitations under section 461(l) will be a welcome relief in the current economic climate. However, certain actions may be necessary in order to appropriately navigate the retroactive changes. Accordingly, taxpayers are well advised to consult with their tax advisors as soon as possible.