Inflation Reduction Act extends ‘pass-through’ tax break limits for 2 more years. Here’s what that means for entrepreneurs

Senator Majority Leader Chuck Schumer (D-N.Y.) discusses the Inflation Reduction Act, Aug. 7, 2022 in Washington D.C.

Kent Nishimura | Los Angeles Times | Getty Images

Senate Democrats reduced a tax break for certain pass through businesses as part the Inflation Reduction Act, which was passed Sunday.

A flow-through, or pass-through, business reports its income on its owners’ tax returns. This income is subject to tax at the owners’ individual income tax rates. Pass-throughs include sole proprietorships and limited liability companies, partnerships, and S-corporations.

Democrats’ legislation — a package of health-care, tax and historic climate-related measures — limits the ability of pass-throughs to use big paper losses to write off costs like salaries and interest, according to tax experts.

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That limit — called the Limitation on Excess Business Losses — is currently already in place. It was originally set to expire in 2027. However, the new bill would extend it for an additional two-year period. This extension was not in the Senate Democrats’. initialVersion of the legislation, but it was modified during the subsequent negotiation and amend process.

The Inflation Reduction Act was voted for by all parties and is now headed to the House.

Wealthy real estate owners likely impacted most

The pass-through limitation was originally enacted by Republicans in the 2017 tax law, known as the Tax Cuts and Jobs Act.

Pass-through owners are prohibited from using business losses exceeding $250,000 in order to offset non-business income. The dollar threshold is only for single taxpayers. For married couples filing joint tax returns, the law sets a $500,000 limit.

These caps are higher due to inflation adjustment in 2022: $270,000 and $540,000.

Steve Rosenthal, a Senior Fellow at the Urban-Brookings Tax Policy Center, stated that the business losses cannot be offset by other income. This includes salaries, interest, and investment gains.

Rosenthal said that the provisions were detrimental to “rich guys” who were using their business losses for tax write-offs against salaries, bonuses, or investment income.

Any pass-through business that suffers a significant operating loss each year can theoretically be subject to these limitations. But real estate businesses — which can use rules around depreciation to consistently rack up big losses on paper — are likely among the most affected categories, according to Jeffrey Levine, a certified financial planner and certified public accountant based in St. Louis.

It’s a big deal for those who have a lot of real property.

Jeffrey Levine

Buckingham Wealth Partners Chief Planning Officer

“It is a huge deal for uber-wealthy individuals with a ton real estate and then the occasional businesses that lose a lot each year,” Levine, who also serves as chief planning officer at Buckingham Wealth Partners.

Initially, the limitation on pass-throughs was to expire after 2025. This was in addition to other provisions of the Republican tax law which affected individual taxpayers.

Democrats extended the limit by adding an additional year to the American Rescue Plan, which President Biden signed in 2021. The Joint Committee on Taxation estimatedThis one-year extension would bring in $31 billion.

Rosenthal stated that the Inflation Reduction Act’s extra extension would presumably raise roughly the same amount each year.

The business losses won’t disappear forever, however. If Congress does not extend the limitation, owners may be able defer tax benefits to future years.

Rosenthal stated that “the losses almost always get claimed later.”

Source: CNBC

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