The Excess Business Loss (EBL) limitation under Section 461(l) of the Internal Revenue Code is one of the most significant—yet often overlooked—tax restrictions affecting individuals, trusts, and estates with passthrough business income. Enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017 and later permanently extended by the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21), this provision caps the amount of trade or business losses a noncorporate taxpayer may deduct in any given year.
Originally set to expire after 2025, the OBBBA made the limitation permanent for tax years beginning after December 31, 2020. The Inflation Reduction Act (IRA) of 2022 had previously extended the limitation through 2028. With the OBBBA, that temporary bridge has become a permanent fixture of the tax landscape.
🔢 Who Is Subject to Section 461(l)?
The limitation applies to noncorporate taxpayers, including:
- Individuals (filing as single, head of household, married filing jointly, or married filing separately);
- Estates; and
- Trusts (including trusts subject to tax under section 511).
📌 C corporations are not subject to Section 461(l) and remain governed by the corporate net operating loss (NOL) rules (including the 80% taxable income limitation).
💰 2025 Threshold Amounts (Indexed for Inflation)
For the 2025 tax year, the EBL threshold amounts are:
| Filing Status | Threshold Amount |
| Married Filing Jointly (MFJ) | $626,000 |
| Single, Head of Household (HOH), Married Filing Separately (MFS) | $313,000 |
The thresholds are adjusted annually for inflation under the authority of Rev. Proc. 2024-40, Sec. 2.32.
📉 Defining “Excess Business Loss”
Under Section 461(l)(3), an excess business loss is defined as the amount by which a taxpayer’s aggregate trade or business deductions exceed the sum of:
- The taxpayer’s aggregate trade or business gross income or gains; plus
- The applicable threshold amount for the tax year.
The term “trade or business” excludes the performance of services as an employee.
Formula:
Excess Business Loss = Total Business Deductions − (Total Business Gross Income + Threshold Amount)
Example (2025 MFJ): A married couple with 500,000 of business gross income. Their excess business loss is
500,000 +
126,000) excess**, which is disallowed in the current year.
🔁 Treatment of Disallowed Losses – NOL Carryforward
Losses disallowed under Section 461(l) do not disappear. Pursuant to Section 461(l)(2), any disallowed excess business loss is automatically treated as a net operating loss (NOL) carryover to the following taxable year under Section 172.
As an NOL carryforward, the disallowed amount is subject to the 80% taxable income limitation under Section 172(a)(2). Any remaining NOL amount is carried forward indefinitely to subsequent tax years.
📋 The Four-Tier Loss Limitation Framework
The EBL limitation is not applied in isolation. It is the fourth and final tier of loss limitations that passthrough owners must work through in a specific statutory hierarchy.
Tier 1: Basis Limitations
- Section 704(d) (partnerships): A partner may deduct losses only to the extent of their adjusted basis in the partnership interest.
- Section 1366(d) (S corporations): A shareholder may deduct losses only to the extent of their stock and debt basis.
Tier 2: At‑Risk Limitations (Section 465)
- Limits deductions to the amount the taxpayer has “at risk” in the activity (generally cash contributed and certain nonrecourse debt).
Tier 3: Passive Activity Loss (PAL) Limitations (Section 469)
- Losses from passive activities (including most rental real estate activities) may only offset passive income, with limited exceptions for qualifying real estate professionals.
Tier 4: Excess Business Loss Limitation (Section 461(l))
- Applied after all Tier‑1, Tier‑2, and Tier‑3 limitations.
- Calculated using Form 461, Limitation on Business Losses.
📑 Compliance and Filing: Form 461
Taxpayers must file Form 461 if:
- Aggregate net losses from all trades or businesses exceed the annual threshold (
626,000 for 2025); OR
- Any single trade or business loss exceeds half the threshold amount (
313,000 for MFJ in 2025).
To complete Form 461:
- Aggregate all trade or business income and deductions (from Schedules C, E, F, and K‑1).
- Exclude any deductions, gross income, or gains attributable to the performance of services as an employee.
- Compute net business loss as deductions minus income/gains.
- Subtract the annual threshold amount.
- Any remaining loss is the excess business loss.
The excess business loss is reported as a positive adjustment upon Form 1040, Schedule 1, Line 8p (designated “ELA”).
🏛️ State Conformity to Section 461(l)
State conformity to Section 461(l) varies significantly. A high‑level summary:
California
California generally conforms to Section 461(l), but with modifications under Cal. Rev. & Tax Code §17560.5. The state:
- Applies the limitation for tax years beginning after December 31, 2018.
- Treats disallowed losses as “carryover excess business losses” rather than NOL carryforwards.
- California has not conformed to certain CARES Act amendments.
📌 California Form FTB 3461 is required for state EBL calculations.
New York
New York generally conforms to the Internal Revenue Code as amended, though taxpayers should consult Form IT‑201 and applicable instructions, as specific guidance on Section 461(l) continues to evolve.
Massachusetts
Massachusetts generally conforms to the Code as currently in effect for trade or business expense deductions. However, following the OBBBA, the Massachusetts DOR has indicated possible legislative decoupling from certain OBBBA provisions, and taxpayers should exercise caution in relying on draft guidance.
Texas
Texas imposes no personal income tax; however, for purposes of the Texas Franchise Tax, losses are generally computed following federal tax principles, subject to Texas‑specific modifications. Section 461(l) may indirectly affect federal taxable income used as the starting point for Texas margin‑based franchise tax calculations.
⚖️ Case Law and Litigation
To date, reported judicial opinions directly interpreting Section 461(l) remain limited, largely due to the provision’s relatively recent enactment (TCJA 2017). Most guidance continues to come from administrative sources such as IRS notices and proposed regulations.
However, proposed regulations (RIN 1545-BP05) addressing Section 461(l) have been developed to clarify:
- How the excess business loss is calculated;
- How excess business losses are allocated among multiple trades or businesses; and
- How the resulting NOL is treated in subsequent taxable years.
These proposed regulations remain in the rulemaking stage, and no final regulations have been promulgated as of 2026.
Mann v. United States (case number referenced in court filings) addressed distinct issues relating to damages awards and does not constitute precedent for Section 461(l) EBL matters.
⚠️ Planning Considerations
- Proactive Cash Flow Management – The EBL limitation can result in a tax liability in a year when a business generates substantial losses. Taxpayers with significant nonbusiness income (wages, capital gains, dividends, etc.) should model their EBL exposure before year‑end.
- Real Estate Professionals – Even if a taxpayer qualifies as a real estate professional under Section 469(c)(7), Section 461(l) still applies to limit rental real estate losses that exceed the annual threshold.
- Bonus Depreciation Interactions – Large losses from 100% bonus depreciation may trigger the EBL limitation, creating federal‑state taxable income disparities. Bonus depreciation is deductible for federal purposes but may be subject to state add‑back modifications, resulting in state tax liability even with a federal loss.
- Converting W‑2 Income to Business Income – The CARES Act clarified that employee compensation is not business income for EBL purposes. However, converting employment income to business income through independent contractor arrangements may increase the pool of income against which business losses can be offset.
📌 Important Disclosure Regarding Legislative Changes
📣 DISCLAIMER: Tax laws, regulations, and judicial interpretations are subject to frequent change. The One Big Beautiful Bill Act (OBBBA) made the excess business loss limitation permanent as of 2025, but future legislative amendments, administrative guidance (including final regulations), state decoupling legislation, and court decisions may alter the application of Section 461(l). State conformity rules vary by jurisdiction and are frequently amended. The information contained in this post is provided for educational purposes only and does not constitute legal or tax advice. You should consult with a qualified tax professional regarding your specific circumstances.
📞 For More Information If you have questions about how the excess business loss limitation applies to your situation—or to discuss proactive planning strategies—please contact Alan Goldstein
Was this helpful?
0 / 0