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Inflation Reduction Act limits pass-through tax break for two more years

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

Kent Nishimura | Los Angeles Times | Getty Images

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

A pass-through or flow-through business is one which reports its income on the tax returns of its owners. That income is taxed at their individual income tax rates. Examples of pass-throughs include sole proprietorships, some limited liability firms, partnerships and S-corporations.

Democrats’ laws — a package of health-care, tax and historic climate-related measures — limits the power of pass-throughs to make use of big paper losses to write down off costs like salaries and interest, in accordance with tax experts.

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That limit — called the Limitation on Excess Business Losses — is currently already in place. It was scheduled to finish starting in 2027, but the brand new bill would extend the restriction for a further two years. That extension wasn’t in Senate Democrats’ initial version of the laws, nevertheless it was added throughout the subsequent negotiation and amendment process.

The Inflation Reduction Act passed along party lines and now heads to the House.

Wealthy real estate owners likely impacted most

Republicans originally enacted the pass-through limitation within the 2017 tax law often called the Tax Cuts and Jobs Act.

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

Those caps are higher in 2022 attributable 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,” Steve Rosenthal, a senior fellow on the Urban-Brookings Tax Policy Center, said of the measure.

The provisions hurt “wealthy guys” who were using business losses to take tax write-offs against bonuses, salaries and investment income, for instance, said Rosenthal.

The constraints can theoretically apply to any pass-through business that runs up an enormous operating loss every year. But real estate businesses — which may use rules around depreciation to consistently rack up big losses on paper — are likely amongst essentially the most affected categories, in accordance with Jeffrey Levine, a licensed financial planner and authorized public accountant based in St. Louis.

It’s a very big deal for uber-wealthy individuals with a ton of real estate.

Jeffrey Levine

chief planning officer at Buckingham Wealth Partners

“It’s a very big deal for uber-wealthy individuals with a ton of real estate, after which the occasional business that loses a ton of cash every 12 months,” said Levine, who can also be chief planning officer at Buckingham Wealth Partners.

The limitation for pass-throughs was initially scheduled to run out after 2025, together with the opposite provisions of the Republican tax law that affected individual taxpayers.

Nonetheless, Democrats prolonged the limit for a further 12 months within the American Rescue Plan, which President Biden signed into law in 2021. The Joint Committee on Taxation estimated that that one-year extension would raise about $31 billion.

The Inflation Reduction Act’s additional extension would presumably raise a roughly similar amount of cash every year, Rosenthal said.

Nonetheless, the business losses don’t necessarily disappear eternally. Owners may find a way to defer the tax advantages to future years, if Congress doesn’t extend the limitation again.

“The losses almost all the time get claimed later,” Rosenthal said.

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