COVID-19 has thrown a wrench into many business owners’ plans and strategies for their organizations. Recognizing that the Coronavirus pandemic and the economic fallout that will inevitably follow and endure beyond the stay-at-home orders, Congress passed the Coronavirus Aid, Relief, and. Economic Security (CARES) Act. The law most notably provides individuals under certain income thresholds a one-time $1,200 payment, but also contains several provisions that may be helpful for businesses and their owners. This article will cover the easing of restrictions previously in place relating to excess business loss (EBL) utilization. Because the utilization of CARES Act provisions can impact other areas of the business’s tax and financial profile, taxpayers should consult with our COVID-19 Business Survival Consulting team to determine the best course of action.
What is an Excess Business Loss and What Are the Limitations?
Excess business losses come into play when a noncorporate taxpayer (such as an individual, trusts, or estate) actively participates in a business activity that generates loss. Generally, losses can work to offset other taxable income. As a part of the Tax Cuts and Jobs Act, passed and signed into law in late 2017, section 461(l) was added to the Internal Revenue Code. Section 461(l) limits the use of excess business losses to offset other items of income to $250,000 for individuals and $500,000 for married couples filing jointly. Any business loss beyond the limits laid out above was carried over as a Net Operating Loss (NOL).
Example – 461(l) Excess Business Loss
Suppose Individual A receives $275,000 in interest income, $50,000 of business income and $400,000 of business loss. Individual A actively participates in both business activities that produced the business income and loss. Absent any excess business loss limitations, Individual A’s $400,000 of business loss would be enough to offset his interest and business income, with an additional $100,000 of loss to spare.
The excess business loss rules require Individual A to first net his business income and loss. Here, Individual A has net business loss of $350,000 ($50,000 of business income less $400,000 of business loss). Individual A’s business loss is limited to $250,000 under section 461(l) and can be used to partially offset his interest income, resulting in $25,000 of interest income subject to tax. The $100,000 of excess business loss that could not be used because of section 461(l) is carried over as a NOL.
How Does the CARES Act Ease Section 461(l) Excess Business Loss Restrictions?
The CARES Act removes the section 461(l) limitation for tax years 2018, 2019, and 2020, effectively allowing taxpayers who were otherwise disallowed from utilizing all their business losses to do so. The overall intent of the tax provisions included in the CARES Act is to allow taxpayers to either (1) pay less tax upon filing their 2019 tax returns and (2) allow for refunds for prior tax years. The elimination of the excess business loss restrictions for 2018, 2019, and 2020 helps taxpayers achieve that objective.
Discussing Your Options with Experienced Business Tax Professionals
If you are considering utilizing one or more of the CARES Act tax provisions or are considering taking a loan under one of the COVID-19 loan programs, it is in your best interest to discuss your options with an experienced business and tax attorney. Amending your tax return from prior years, for instance, can have effects on future year returns and often requires an in-depth cost-benefit analysis. Many of the CARES Act tax provisions and their consequences are not as straightforward as they may seem. Your COVID-19 Business Survival Consultant will ensure that you have considered all of the available options and are making the best decision for your business.
Should I be Cautious in Generating or Utilizing my Excess Business Losses?
Throwing off business losses from your business while maintaining a luxurious lifestyle is a huge red flag. Imaging the IRS learning that a taxpayer lives across the street from the beach, drives a Maserati, eats at expensive restaurants and has lost 3 million dollars in their business over the last 4 years. The IRS or FTB might launch a criminal tax investigation and utilizes several economic methods to prove tax fraud has occurred. Additionally, Net operating loss and capital loss carryforwards can be challenged with an unlimited statute of limitations. My suspicion is that the IRS is going to be under huge pressure by Congress to minimize the tax gap and increase collections considering all the large ticket COVID-19 bailout provisions that the federal government is currently handing out. Additionally, it is very hard to qualify for any type of loan with a history of losses.
Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed returns coupled with affirmative evasion of payment) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation / prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.
It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.
Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for voluntary disclosure.
As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, Kovel CPAs and EAs, our firm provides a one stop shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!
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Regardless of your business or estate needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.
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