Inflation Reduction Act limits passed-on tax benefit for another 2 years

Majority Leader Chuck Schumer, DN.Y., discusses the Inflation Reduction Act on August 7, 2022 in Washington, D.C.

Kent Nishimura | Los Angeles Times | Getty Images

Senate Democrats have curtailed a tax break for certain pass-through companies as part of the Inflation Reduction Act passed Sunday.

A pass-through or conduit business is a business that reports its income in its owners’ tax returns. That income is taxed at their individual income tax rates. Examples of pass-throughs include sole proprietorships, some limited liability companies, partnerships, and S corporations.

Democrats’ legislation — a package of health care, tax and landmark climate action measures — limits the ability of pass-throughs to use large paper losses to write off costs such as salaries and interest, tax experts say.

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That limit — called the excess operating loss limitation — is already in place at the moment. It was scheduled to end from 2027, but the new law would extend the restriction for another two years. That extension was not in the first draft of the Senate Democrat legislation, but was added during the subsequent negotiation and amendment process.

The Inflation Reduction Act went along party lines and now goes to the House.

Wealthy property owners are probably the hardest hit

Republicans originally introduced the pass-through restriction in the 2017 tax law known as the Tax Cuts and Jobs Act.

Specifically, the law prohibited pass-through owners from using business losses in excess of $250,000 to offset non-business income. That dollar threshold is for single taxpayers; the law set a maximum of $500,000 for a married couple filing a joint tax return.

Those limits will be higher in 2022 due to an inflation adjustment: $270,000 and $540,000, respectively.

“The business losses can only offset other business income, not salaries and interest and investment gains,” said Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, of the measure.

The provisions target “rich men” who used business losses to write off tax write-offs for things like bonuses, salaries and investment income, Rosenthal said.

The restrictions could theoretically apply to any pass-through company that incurs a large operating loss each year. But real estate companies — which can use depreciation rules to consistently post large losses on paper — are probably among the most affected categories, according to Jeffrey Levine, a certified financial planner and certified public accountant in St. Louis.

It’s a really big deal for uber-rich people with a ton of real estate.

Jeffrey Levine

chief planning officer at Buckingham Wealth Partners

“It’s a really big deal for very wealthy people with a ton of real estate, and then the occasional business that loses a ton of money every year,” said Levine, who is also chief planning officer at Buckingham Wealth Partners.

The restriction on pass-throughs was initially set to expire after 2025, along with the other provisions of the Republican tax law that affected individual taxpayers.

However, the Democrats extended the limit by an extra year in the US bailout plan, which President Biden signed into law in 2021. The Joint Tax Committee estimated that that one-year extension would bring in about $31 billion.

The additional extension of the Inflation Reduction Act would presumably bring in about the same amount each year, Rosenthal said.

However, the business losses don’t necessarily disappear forever. Owners may be able to defer the tax breaks to future years if Congress doesn’t renew the restriction.

“The losses are almost always claimed later,” Rosenthal said.

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