Excess Business Loss Problems

To a tax accountant, October 15 signifies the extended due date for individual tax returns.

As a generalization, our most complicated returns go on extension. There is a reason: it is likely that the information necessary to prepare the return is not yet available. For example, you are waiting on a Schedule K-1 from a partnership, LLC or S corporation. That K-1 might not be prepared until after April 15. There is only so much work an office of accountants can generate within 75 days, irrespective of government diktats.

More recently I am also seeing personal returns being extended because we are expecting a broker’s information report to be revised and perhaps revised again. It happens repetitively.

Let’s talk about a new twist for 2018 personal returns. There are a few twists, actually, but let’s focus on the “excess business loss” rule.

First, this applies only to noncorporate taxpayers. As noncorporate taxpayers, that could be you or me.

Its purpose is to stop you or me from claiming losses past a certain amount.

Now think about this for a moment.

Go out there, sign a sports contract for big bucks and Uncle Sam is draped all over you like a childhood best friend.

Get booted from the league, however, and you get a very different response.

How can losses happen?

Easy. Let me give you an example. We represent a sizeable contractor. The swing in their numbers from year-to-year can gray your hair. When times are good, they are virtually printing money. When times are bad, it feels like they are taking-on the national debt.

I presume one does not even know the meaning of risk if one wants to be an owner there.

To me, fairness requires that the tax law share in my misery when I am losing money if it also wants me to cooperatively send taxes when I am making money. Call me old-fashioned that way.

The “excess business loss” rule is not concerned with old-fashioned fairness.

Let’s use some numbers to make sense of this.

          Dividends                      100,000

 Capital gains                  400,000

          Schedule K-1                (600,000)

The concept is that you can offset a business loss against nonbusiness income, but only up to a point. That point is $250,000 if you are nonmarried and twice that if you are. Using the above numbers, we have:

 Dividends                       100,000

          Capital gains                  400,000

          Schedule K-1                (600,000)

                                                   (100,000)

          Excess business loss     100,000

         

Interest, dividends and capital gains are the classic nonbusiness income categories. You are allowed to offset $500,000 of nonbusiness income (assuming married) but you are showing $600,000 of business losses. The excess business loss rule will magically adjust $100,000 into your income tax return to get the numbers to work.

It is like a Penn and Teller show.

Let’s tweak our example:

Wages                            100,000

Dividends                       100,000

         Capital gains                  400,000

         Schedule K-1                (600,000)

What now? Do you get to include that W-2 as part of your business income, meaning that you no longer have a $100,000 excess business loss?

Believe it or not, tax professionals are not certain.

Here is what sets up the issue:

The Joint Committee of Taxation published its “Bluebook” describing Congress’ intention when drafting the Tax Cuts and Jobs Act. In it, the JCT states that “an excess business loss … does not take into account gross income, or gains or deductions attributable to the trade or business of performing services as an employee.”        

The “trade or business of performing services as an employee” is fancy talk for wages and salaries.

However, the IRS came out with a shiny new tax form for the excess business loss calculation. The instructions indicate that one should add-up all business income, including wages and tips.

We have two different answers.

Let’s get nerdy, as it matters here.

Elsewhere in the Code, we also have a new 20% deduction for “qualified business income.” The Code has to define “business income,” as that is the way tax law works. The Code does so by explicitly excluding the trade or business of “being an employee.”

There is a concept of statutory construction that comes into play. If one Code section has to EXPLICITLY exclude wages (that is, the trade or business of being an employee), then it is reasonably presumable that business income includes wages.

Which means foul when another Code section pops up and says “No, it does not.”

Of course, no one will know for certain until a court decides.

Or Congress defies all reasonable expectations and actually works rather than enable the Dunning-Kruger psychopaths currently housed there.

Why does this “excess business loss” Code section even exist?

Think $150 billion in taxes over 10 years. That is why.

To be fair, the excess is not lost. It carries over to the following year as a net operating loss.

That probably means little if you have just lost your shirt and I am calling you to make an extension payment on April 15 – you know, because of that “excess business loss” thing.

Meanwhile tax professionals have to march on. We cannot wait. After all, those noncorporate returns are due October 15.