Tax Reform Changes Affecting Partnerships and LLCs and Their Owners
The Tax Cuts and Jobs Act (TCJA) includes several changes that affect partnerships and their partners, and LLCs that are treated as partnerships for tax purposes and their members. Most of the changes are good news. Here are some highlights:
Technical Termination Rule Repealed (Good)
Under prior law, a partnership or an LLC treated as a partnership for tax purposes was considered terminated for federal income tax purposes if, within a 12-month period, there was a sale or exchange of 50 percent or more of the partnership’s or LLC’s capital and profits interests. Fortunately, the TCJA repealed the technical termination rule, effective for partnership or LLC tax years beginning in 2018 and beyond. This is a permanent change.
Lower Tax Rates for Individual Partners and LLC Members (Good)
For 2018 through 2025, the TCJA retains seven tax rate brackets for ordinary income and net short-term capital gains recognized by individual taxpayers, including income and gains passed through to individual partners and LLC members. Six of the rates are lower than before. In 2026, the rates and brackets that were in place for 2017 are scheduled to return, but skeptics doubt that will happen.
Unchanged Rates for Long-Term Gains and Qualified Dividends (Not Good)
The TCJA retains the 0, 15, and 20 percent tax rates on long-term capital gains and qualified dividends recognized by individual taxpayers, including gains and dividends passed through to individual partners and LLC members. After 2018, these brackets will be indexed for inflation.
New Pass-Through Business Deduction (Good)
For tax years beginning in 2018-2025, the TCJA establishes a new deduction based on your share of qualified business income (QBI) passed through from a partnership or LLC. The deduction generally equals 20 percent of QBI, subject to restrictions that can apply at higher income levels.
New Limits on Deducting Business Losses (Not Good)
For 2018-2025, the TCJA made two changes to the rules for deducting an individual taxpayer’s business losses. Unfortunately, the changes are not in your favor.
For tax years beginning in 2018-2025, you cannot deduct an excess business loss in the current year. An excess business loss means the amount of a loss in excess of $250,000, or $500,000 if you are a married joint-filer. The excess business loss is carried over to the following tax year, and you can then deduct it under new rules for deducting net operating loss (NOL) carryforwards, explained below.
Key Point: This new loss disallowance rule applies after applying the passive activity loss (PAL) rules. So if the PAL rules disallow your business loss, you don’t get to use the new loss disallowance rule.
For NOLs arising in tax years beginning in 2018 and beyond, the TCJA stipulates that you generally cannot use an NOL carryover to shelter more than 80 percent of taxable income in the carryover year. Under prior law, you could generally use an NOL carryover to shelter up to 100 percent of your taxable income in the carryover year.
Another TCJA change stipulates that NOLs arising in tax years ending after 2017 generally cannot be carried back to an earlier tax year. You can carry such losses forward only. But you can carry them forward indefinitely. Under prior law, you could carry an NOL forward for no more than 20 years.