Excess Business Loss Limitation: Section 461(l)

The excess business loss limitation under section 461(l) caps the net business loss a noncorporate taxpayer can deduct against non-business income in one year. Losses above an indexed threshold (US$256,000, or US$512,000 joint, for 2026) are disallowed for the year and carried forward as a net operating loss. The 2025 legislation made the limitation permanent.

On this page

1. What does the rule do?
2. What is the threshold?
3. What counts as business income and loss?
4. Where does it sit in the ordering?
5. Who does it catch?
6. Worked example
7. Frequently asked questions
8. Related guides
9. Official sources
10. Next step

What does the rule do?

Before 2018, a pass-through owner with a US$900,000 business loss and a spouse with US$600,000 of wages could offset all of the wages and carry the rest back or forward. Section 461(l) inserts a ceiling: the aggregate deductions from all the taxpayer's trades or businesses may exceed the aggregate gross income from those businesses only by the threshold amount. Anything beyond is an "excess business loss," not deductible that year, and converted into an NOL carryforward to the next year (where the 80 percent NOL cap applies to it). The loss is deferred, not denied — but the deferral can be long for a taxpayer with large business losses and large non-business income.

What is the threshold?

The thresholds were set at US$250,000 / US$500,000 in 2018 and indexed, reaching US$313,000 / US$626,000 for 2025. The 2025 legislation re-based the inflation adjustment to 2024, so the 2026 figures fell to US$256,000 / US$512,000; the joint amount is always exactly twice the single. The limitation first applied for 2018 through 2025 (suspended for 2018–2020 by the CARES Act), was extended through 2028 by later legislation, and the 2025 legislation made it permanent.

What counts as business income and loss?

All trades or businesses of the taxpayer, aggregated: Schedule C and F, the taxpayer's share of partnership and S corporation business income and loss, but not wages: income and deductions from working as an employee are excluded from the computation, so W-2 wages never raise the threshold — though a business loss up to the threshold can still offset them. Gains and losses from selling business property (section 1231) are included; capital gains from investments and other portfolio income are not. Rental activities are trades or businesses for this purpose if they are trades or businesses generally. The computation is on Form 461, attached to the return.

Where does it sit in the ordering?

Business losses pass through three gates before reaching the taxpayer's other income:

1. The at-risk rules (section 465, Form 6198) — a loss is allowed only to the extent of the amount the taxpayer has at risk in the activity.
2. The passive activity rules (section 469, Form 8582) — a loss from an activity the taxpayer does not materially participate in is allowed only against passive income (the passive activity guide).
3. The excess business loss limitation (section 461(l), Form 461) — the surviving business losses are capped at the threshold against non-business income.

Losses suspended at the first two gates never reach the third; only losses that clear at-risk and passive limits are tested under 461(l). For an S corporation shareholder, the stock-and-debt basis limitation applies even earlier.

Who does it catch?

Owners with a large one-year loss and substantial income elsewhere: a business that expenses a fleet or a building under bonus depreciation in a year when the spouse earns well; a real estate professional with cost-segregation losses against a large salary; a startup founder funding losses from investment income; a farmer in a disaster year. The limitation is why the bonus depreciation guide notes that a loss "can be created" but not necessarily used, and why electing out of bonus or spreading section 179 sometimes makes sense for a high-income household.

Worked example

A married couple: she owns an HVAC company (S corporation) that loses US$750,000 this year after expensing four trucks and a warehouse build-out under bonus depreciation; he earns US$600,000 in wages; they have US$60,000 of investment income. She has basis and is active (at-risk and passive gates pass). The 2026 joint threshold is US$512,000. Business loss US$750,000 exceeds the threshold by US$238,000: US$512,000 is deductible this year against his wages and their investment income; US$238,000 is an excess business loss, carried forward as an NOL to next year, where it offsets up to 80 percent of that year's taxable income. Had she instead elected out of bonus depreciation on the warehouse build-out (US$300,000), this year's loss would have been US$450,000 — fully deductible — and the build-out, as qualified improvement property in an existing building, would depreciate over fifteen years, likely in higher-income years.

Frequently asked questions

Official sources

The Instructions for Form 461 state: “An excess business loss is the amount by which the total deductions (computed without regard to any deduction allowed under section 172 or 199A) from your trades or businesses are more than your total gross income or gains from your trades or businesses, plus the threshold amount.” — Internal Revenue Service, Instructions for Form 461, Limitation on Business Losses, https://www.irs.gov/instructions/i461

The Instructions for Form 172 state: “Excess business losses that are disallowed are treated as an NOL carryover to the following tax year.” — Internal Revenue Service, Instructions for Form 172, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, https://www.irs.gov/instructions/i172

Next step

Fairlight Accounting is a cross-border accounting and tax practice with a U.S. Tax Desk and a Canadian Tax Desk. Our U.S. Tax Desk handles loss-limitation modeling across the basis, at-risk, passive, and excess business loss rules, Form 461 preparation, and elect-out decisions on bonus depreciation for high-income households. See pricing or book a call.