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Modification of Limitation on Losses for Noncorporate Taxpayers

Before the enactment of the 2017 TCJA, noncorporate taxpayers were allowed to use business deductions to reduce or eliminate their nonbusiness income in the same tax year. 

The TCJA added a provision disallowing the deduction of “excess business losses” by noncorporate taxpayers for tax years beginning after Dec. 31, 2017, and ending before Jan. 1, 2026. An excess business loss is the excess of the (1) taxpayer’s aggregate trade or business deductions for the tax year over (2) the sum of the taxpayer’s aggregate trade or business gross income or gain plus $250,000 ($500,000 for joint filers), adjusted for inflation. The statute did not explicitly exclude wages from the definition of business income, which allowed taxpayers to offset losses from partnerships, etc. against salary income with no limitation. The disallowed loss is treated as a net operating loss carryover to the following year.

The CARES Act temporarily modifies the loss limitation for noncorporate taxpayers so they can deduct excess business losses arising in years before 2021. The provision also includes technical corrections clarifying that excess business losses do not include any deduction under Code Sec. 172 (net operating losses) or Code Sec. 199A (qualified business income) or any income or deductions related to performing services as an employee. It also makes a technical correction clarifying the extent to which capital gains are taken into account in determining an excess business loss.

Example: In 2018, Susie Arman, who is single, had wages of $175,000 and a loss from her S corporation of $500,000. She had income from investments of $300,000. Under the TCJA, Susie had an excess business loss $75,000 ($500,000 – $175,000 – $250,000), leaving her with $50,000 of taxable gross income. The unused loss of $75,000 is treated as a net operating loss carryover to 2019.

Under the CARES Act, Susie can use her full S corporation loss to fully offset her wage and investment income. She can file an amended return to recover any taxes originally paid for 2018, and there is no net operating loss carryover to 2019.

Retirement Plan Distributions and Loans

Retirement accounts are often used as a last resort emergency fund in desperate times. Congress recognizes this and made temporary changes to the law to soften the consequences of withdrawing money for those adversely affected by the Coronavirus.  

Retirement Plan Distributions

For 2020, qualifying individuals may withdraw up to $100,000 from a retirement account without incurring the 10% early withdrawal penalty. Furthermore, income recognition of this distribution can be spread out over three years beginning in 2020 (it has historically been one year). Should an individual’s financial situation improve in the three years following the distribution, he or she will be able to contribute their $100,000 distribution back to the plan and avoid income recognition.  

An individual will qualify for these relaxed distribution rules if he or she, a spouse, or dependent is diagnosed with the coronavirus. One also qualifies if suffering from financial difficulty as a result of being quarantined, furloughed, laid off, having work hours reduced, or being unable to work due to lack of childcare.  

Retirement Plan Loans

Qualifying individuals may borrow the lesser of $100,000, or 100% of a retirement account balance within 180 days from the date of the enactment of this law (March 27^th). Previously, the maximum loan amount was the lesser of $50,000 or 50% of the account balance. Repayments of these loans and any other outstanding retirement account loans can be delayed for up to one year. This rule applies to the same individuals who qualify for the relaxed distribution rules discussed above.

Required Minimum Distribution (“RMD”) Rule Suspended for 2020

An individual who turned 70½ prior to 2020 (or 72 after 2019)  is generally required to withdraw an RMD from his or her retirement account. This distribution is calculated using the previous year’s ending account balance.  A 2020 distribution is therefore calculated using the account balance on December 31, 2019.  

The stock market was near its peak at the end of 2019 and has since dropped significantly because of the coronavirus outbreak. A 2020 distribution not taken before the market downswing will be calculated using the higher account balance from the end of the previous year when the market was near its peak but taken from an account that is now much lower in value. In this scenario, a retiree will be forced to take a larger distribution at a time when the account balance is low, reducing future income potential and possibly threatening retirement security.  

Congress, therefore, suspended the requirement for an individual to take an RMD in 2020. This applies to most defined benefit plans and IRAs. In addition, for distributions required to be made within five years of the death of an employee, the five-year period is determined without regard to the calendar year 2020.

If you would like additional information please contact your Gettry Marcus Advisor or Robert Thee, the author of this article.