Modification and Extension of Limitation on Excess Business Losses of Noncorporate Taxpayers

Summary

Section 461(l) limits the amount of aggregate net business loss that a taxpayer other than a corporation may deduct in a tax year. The rule can affect sole proprietors, partners, S corporation shareholders, and certain estates and trusts even when the underlying loss is otherwise deductible under the normal tax rules.

The One Big Beautiful Bill Act (OBBBA) made the limitation permanent and changed the inflation-adjustment base used to determine the annual thresholds. The practical result is that taxpayers should no longer plan for Section 461(l) to expire. They should also update projections for the lower 2026 thresholds.

Background 

An excess business loss” is generally the amount by which a noncorporate taxpayer’s aggregate deductions attributable to trades or businesses exceed the taxpayer’s aggregate business income and gains plus the applicable annual threshold. The calculation is made at the individual owner level, not at the partnership or S corporation level, and generally aggregates the taxpayer’s business activities. It is computed without regard to Section 172 and Section 199A deductions, excludes items attributable to services performed as an employee, and applies special rules to capital gains and losses.

For 2025, the threshold is $313,000, or $626,000 for a married couple filing a joint return. Stated another way, a taxpayer with enough nonbusiness income may generally use up to the applicable threshold of net business loss to reduce that other income in 2025. The portion of the aggregate net business loss above the threshold is disallowed for the current year.

The enacted law also resets the inflation-adjustment base. As a result, the 2026 thresholds are lower than the 2025 thresholds:

A loss disallowed under Section 461(l) is not permanently lost. It is treated as a net operating loss (NOL), for the loss year and carried into subsequent taxable years under Section 172. The final legislation preserved this NOL treatment; it did not convert the disallowed amount into a separate recurring excess-business-loss carryforward. Use of a post-2017 NOL in a later year is generally limited to 80% of taxable income, subject to the detailed rules and exceptions in Section 172.

Section 461(l) is applied after other applicable loss limitations. For example, basis, at-risk, and passive activity rules may suspend a loss before it reaches the excess business loss calculation. A loss must first be allowable under those provisions before Section 461(l) determines how much may be used in the current year.

Examples

The following examples illustrate how the Section 461(l) limitation thresholds for 2025 and 2026, excess business losses, and NOL carryforwards may apply in practical client situations.

1. Same S Corporation Loss, Different Filing Status

Assume two sisters each own 50% of the same S corporation. In 2025, the S corporation generates a $1.6 million ordinary business loss, and each sister is allocated an $800,000 loss. The sisters have the same ownership percentage and the same allocated business loss, but one sister files as single and the other files a joint return with her spouse.

For illustration, assume both sisters have sufficient stock and debt basis, are fully at risk, may treat the losses as nonpassive, have no other business income or loss, and have enough nonbusiness income to use the maximum current-year deduction. The example intentionally excludes asset-sale, capital-gain, Section 1231, and state-tax issues.

2. 2026 Sole Proprietor Loss Can Offset Nonbusiness Income up to the Threshold

Assume a single taxpayer has a $500,000 net Schedule C business loss in 2026 that is allowable before Section 461(l), after all applicable loss limitations. The taxpayer has no other business income or gain and has sufficient wage and investment income to absorb the permitted current-year loss. Wages and investment income do not increase the Section 461(l) threshold.

Result: $244,000 is deferred as an NOL. The taxpayer may have substantial nonbusiness income, but the amount of current-year business loss allowed against that income is still capped at the applicable threshold.

3. Profit and Loss from Multiple Businesses Are Aggregated

Assume a single taxpayer has a $700,000 partnership loss that is allowable before Section 461(l) and $300,000 of Schedule C business profit in 2026, with no other business items. Both amounts are business items included in the Section 461(l) calculation, which is applied to the taxpayer’s aggregate business results — not separately to each activity.

Result: the $300,000 business profit reduces the aggregate net business loss before the threshold is applied. The taxpayer deducts $256,000 of net business loss in 2026, and $144,000 becomes an NOL carryforward.

4. Earlier Loss Limitations Can Prevent an Excess Business Loss

Assume a single S corporation shareholder is allocated a $600,000 loss in 2026, but $400,000 is suspended under the shareholder basis limitation. Assume the remaining $200,000 is fully at risk and nonpassive, and the shareholder has no other business income or loss. Only that $200,000 currently allowable loss reaches the Section 461(l) calculation.

Result: there is no excess business loss because the $200,000 loss that reaches Section 461(l) is below the $256,000 threshold. The $400,000 remains suspended under the shareholder basis limitation; it does not become a Section 461(l) NOL.

5. An Excess-Business-Loss NOL May Be Limited Again When Used

The taxpayer carries the $244,000 Section 461(l) excess-business-loss NOL into 2027. Assume the taxpayer has $200,000 of taxable income in 2027 for purposes of the Section 172 limitation, no pre-2018 NOLs, and no other adjustments or exceptions. The NOL deduction is generally limited to 80% of taxable income computed before the NOL deduction, subject to the Section 172 adjustments.

Result: the original loss is deferred rather than lost, but it may not eliminate all taxable income in the carryforward year. This timing difference should be included in cashflow and estimated tax planning.

State Tax Considerations

The federal limitation on excess business losses under Section 461(l) may also have state income tax implications. However, state treatment of Section 461(l) varies, and state conformity rules should be reviewed. States that conform to federal taxable income may generally follow the federal excess business loss limitation while static or selective conformity states may apply state specific modifications or decouple. As this issue is relevant to noncorporate taxpayers expecting significant business losses, federally disallowed losses may also be deferred for state purposes, while nonconforming states may require state adjustments or apply different carryforward or ordering rules.

How Citrin Cooperman Can Help

Clients expecting significant business losses should review the issue before year-end, particularly when projections include pass-through losses, bonus depreciation, cost-segregation deductions, major equipment purchases, or a business disposition. A useful planning model should compare:

• The loss allowable after basis, at-risk, and passive activity limitations;
• The taxpayer-level Section 461(l) result using the correct annual threshold;
• The current-year tax and cash-flow effect of any disallowed loss;
• The timing and limitations on future NOL utilization; and
• Federal and state consequences of any proposed planning step.

Early modeling is especially important for married business owners, taxpayers with several business activities, and clients expecting large amounts of wage or investment income that they intend to offset with business losses.

Contact Gina Linss or Citrin Cooperman’s tax professionals for assistance with navigating these issues.