If you are facing substantial business losses in 2025, you may be subject to unfavorable tax rules. For small business owners, it is important to understand how certain IRS rules like Excess Business Loss (EBL) limitation, Passive Activity Loss (PAL) rules, and Net Operating Loss (NOL) restrictions could impact your tax outcome. Whether you are a real estate investor, partner in a pass-through entity, or other small business owner, knowing limits on loss deductions can help you plan ahead and avoid surprises.
Disallowance Rules
Passive Activity Loss
Owning a business or rental property can make deducting losses more complex, especially when it comes to the passive activity loss (PAL) rules. If you don’t materially participate in the business or rental activity, the IRS considers it “passive,” which limits your ability to deduct losses. Passive losses can only be used to offset passive income—not income from wages or active business activities. Any unused passive losses are suspended and carried forward to future years. However, these suspended losses are fully deductible when you sell the activity or property that generated them.
Excess Business Loss
Once you have cleared the complexities imposed by the PAL rules, you may face another hurdle. The excess business loss (EBL) rules are designed to limit the amount of business losses an individual taxpayer can deduct in a given year. Under these rules, if your net business losses exceed a certain threshold ($313,000 for single filers or $626,000 for joint filers in 2025), the excess loss cannot be deducted immediately. Instead, it becomes a net operating loss (NOL) and is carried forward to offset income in future years.
Both the passive activity loss (PAL) rules and the excess business loss (EBL) rules are applied at the individual taxpayer level. Owners of pass-through entities—such as partnerships, S corporations, or LLCs—report their share of income, gains, deductions, and losses from the Schedule K-1 on their personal tax return (Form 1040). Together, these rules can significantly restrict the immediate tax benefit of business and investment losses, even if the losses are real and substantial.
Net Operating Loss Deductions
While net operating losses (NOLs) can offer valuable tax relief, they come with some drawbacks. One key limitation is that NOLs can only offset up to 80% of taxable income in a future year, which means you may still owe some tax even with large losses. Additionally, since NOLs can no longer be carried back to prior years for an immediate refund, you will wait to see the benefit – potentially for many years.
When it comes to navigating the complexities of excess business losses proactive planning can make a big difference. The Wegner CPAs tax advisors are here to help! Contact us to discuss strategies for managing business losses and how to maximize your future tax benefits.
