Do you expect your manufacturing business to incur a tax loss in
2026 due to sizable deductions for bonus depreciation or domestic research and
experimentation (R&E) expenses? If so, you could face an unwelcome
surprise. The federal tax code limits the amount of business losses you can
deduct in a given year. This limitation applies to sole proprietors and owners
of pass-through businesses (such as S corporations, partnerships and most
limited liability companies).
Excess business loss limitation
Under Section 461(l) of the tax code, noncorporate taxpayers
can't deduct excess business losses in the current year. A loss generally
occurs when a business's expenses and other deductions for the year exceed its
revenue. Such losses generally can offset income from other sources, such as
salary, self-employment income, interest, dividends and capital gains, only up
to the annual limit. An "excess" business loss is typically the amount by which
a taxpayer's total business losses exceed that inflation-adjusted threshold.
For purposes of the excess business loss limitation, total
business deductions are calculated without regard to net operating losses
(NOLs) or the Sec. 199A qualified business income (QBI) deduction. The
calculation also excludes wages earned as an employee of the business. Any
gains from the sale of your business's assets are limited to the lesser of:
1) capital gain net income, or 2) capital gain net income
attributable to the business.
The One Big Beautiful Bill Act (OBBBA) made the excess business
loss limitation permanent and significantly reduced the threshold beginning in
2026. The threshold decreased from $313,000 for 2025 to $256,000 for 2026
(twice those amounts for married couples filing jointly).
Note: If
you have business losses from pass-through entities, the limit applies to you
at the owner
level and is reported on your individual tax return.
As a result, owners of manufacturing businesses that have
incurred hefty losses might not realize the full benefit of those losses on
their 2026 tax bills. Manufacturers are especially vulnerable if they claim
100% bonus depreciation on capital assets (now permanent under the OBBBA) or
the OBBBA's temporary deduction for qualified production property placed in
service after July 4, 2025, and before January 1, 2031. The latter
allows businesses to elect a deduction equal to 100% of the property's adjusted
basis in the tax year it's placed in service, rather than depreciating the
property over the typical 39 years.
The OBBBA also reinstated current deductions for domestic
R&E costs. Manufacturers investing heavily in product development, process
improvements or other qualifying R&E activities may generate substantial
tax losses, potentially increasing their exposure to the excess business loss
limitation.
NOL carryforwards
The good news is that losses exceeding the applicable threshold
are treated as NOL carryforwards that can be applied in future tax years. But
they're subject to the 80% taxable income limitation on NOL deductions, so it
could take some time to reap the full benefits.
You could lose some benefit altogether if your business never
generates enough income to absorb the carryforwards or is sold in the near
future. In addition, an NOL carryforward could end up worth less in future
years if the taxpayer is in a lower tax bracket — or worth more if the taxpayer
is in a higher tax bracket.
Ordering rules
Before applying that limit, you must factor in any other
restrictions that may reduce your deductible business loss. These include
basis, at-risk and passive activity loss (PAL) rules.
Under the basis limitation, an owner generally can't deduct
losses exceeding his or her adjusted tax basis in the pass-through business
interest and any applicable debt basis. Disallowed losses generally can be
carried forward until sufficient basis becomes available.
Sec. 465 generally limits a taxpayer's business loss deduction
to the amount he or she has financially "at risk" in the activity. Losses
exceeding that amount generally are carried forward until the taxpayer has
sufficient amounts at risk to deduct them.
Owners who don't materially participate in their businesses may
be subject to the PAL rules, which generally prevent passive losses from
offsetting wages, active business income and portfolio income, subject to
certain exceptions.
Act now
If you expect to report substantial business losses for 2026,
now is the time to evaluate how the excess business loss limitation and other
tax rules may affect your ability to deduct them. Careful planning can help you
maximize the tax benefits of available deductions, minimize the impact of
potential limitations and make the most of losses carried forward to future
years. Contact us to discuss your situation and identify strategies to
potentially reduce your tax liability.
