Section 461(l) Excess Business Loss Limit After the 2025 Legislation: Permanent Rule, the 2026 Threshold and Form 461

The excess business loss limit in section 461(l) no longer has an end date. Section 70601 of Public Law 119-21 struck the words "and before January 1, 2029" from section 461(l)(1), so the limit applies to every taxable year beginning after December 31, 2026 with no sunset. The same section moved the inflation base year from 2017 to 2024, which lowered the dollar threshold. For 2026 the threshold is $256,000 ($512,000 on a joint return), down from $313,000 ($626,000) for 2025.

Clients with large pass-through losses, such as an equipment-leasing partnership or a start-up S corporation, will see losses that were deductible in a prior year pushed into a carryforward. This article covers the computation, the ordering rules, and the records that support Form 461.

What changed under section 70601?

The section has three effective-date pieces:

• Rule made permanent. Section 70601(a) strikes "and before January 1, 2029" in section 461(l)(1). Under section 70601(c)(1), this applies to taxable years beginning after December 31, 2026.
• Threshold reset. Section 70601(b) changes the date in the preamble to section 461(l)(3)(C) from December 31, 2018 to December 31, 2025, and the base year in clause (ii) from 2017 to 2024. Under section 70601(c)(2), this applies to taxable years beginning after December 31, 2025.
• No change to the NOL rule. The section does not touch the carryover treatment in section 461(l)(2).

The section 461(l)(1) text now reads that for taxable years beginning after December 31, 2020, any excess business loss of a noncorporate taxpayer is not allowed. Section 70601(a) strikes the end date "each place it appears" in section 461(l)(1), so the clause that switches off the excess farm loss limit in section 461(j) loses its end date too.

What is the threshold?

The base amount sits in section 461(l)(3)(A)(ii)(II) at $250,000, doubled for a joint return, and is indexed under section 461(l)(3)(C).

The 2026 revenue procedure states that the amount under section 461(l)(3)(A)(ii)(II) is $256,000 ($512,000 for joint returns). The drop of $57,000 for non-joint filers and $114,000 for joint filers follows from using 2024 rather than 2017 as the base year.

How is an excess business loss computed?

Section 461(l)(3) defines the excess business loss as the excess of aggregate deductions attributable to the taxpayer's trades or businesses over the sum of aggregate gross income or gain from those trades or businesses plus the threshold. Four rules shape the figures:

1. The deductions are computed ignoring the disallowance itself and ignoring any section 172 or 199A deduction.
2. Losses from sales or exchanges of capital assets are excluded from deductions. Capital gains count as business income only up to the lesser of capital gain net income from the trade or business or total capital gain net income.
3. Deductions, income and gain from performing services as an employee are left out, so wages do not offset business losses.
4. For partnerships and S corporations, the limit applies at the partner or shareholder level, using each owner's allocable share of trade or business items in the owner's own year.

Worked example (2026, married filing jointly). A couple has trade or business gross income of $300,000 from a sole proprietorship and a partnership interest, and trade or business deductions of $1,100,000, after the loss limits that apply first.

1. Net business loss: $1,100,000 - $300,000 = $800,000.
2. Threshold: $512,000.
3. Excess business loss: $1,100,000 - ($300,000 + $512,000) = $288,000.
4. Loss allowed in 2026: $800,000 - $288,000 = $512,000.
5. Carryforward: $288,000 treated as a net operating loss.

Same facts for a single filer in two years. Deductions are $700,000 against gross income of $100,000, so the net business loss is $600,000. In 2025 the excess is $600,000 - $313,000 = $287,000. In 2026 it is $600,000 - $256,000 = $344,000, which is $57,000 more disallowed.

How does the disallowed loss carry forward?

Section 461(l)(2) provides that a loss disallowed under paragraph (1) is treated as a net operating loss for the taxable year for purposes of determining any net operating loss carryover under section 172(b). The Form 461 instructions say the excess business loss is treated as an NOL carryover for subsequent years, that taxpayers must keep a record of it each year, and that Form 172 governs carryover reporting.

In the example above, the $288,000 enters the client's NOL schedule for 2027. A preparer who treats it as a suspended loss with its own tracking, outside the NOL schedule, will misstate the carryover.

In what order do the loss limits apply?

The Form 461 instructions state the sequence: first the at-risk rules, next the passive activity loss rules, and then the excess business loss rules. Section 461(l)(6) confirms that the limit applies after section 469. For a partnership or S corporation interest, the instructions say the trade or business determination is made at the entity level.

For a K-1 loss, the working paper should show the owner's basis limit, the at-risk amount, the passive loss disposition, and only then the section 461(l) computation. A loss that is already suspended under an earlier limit does not enter the excess business loss figure until it becomes allowable.

Who files Form 461?

The 2025 instructions say noncorporate taxpayers, including trusts subject to tax under section 511, must file Form 461 if either of two tests is met:

• Net losses from all trades or businesses exceed $313,000 ($626,000 joint), or
• The taxpayer would report a loss of more than $156,500 on any one of Form 461, lines 1 through 8.

What should the file contain?

• A business-activity schedule. Each trade or business with income and deductions listed, with wages and capital items shown separately so the exclusions are visible.
• Limit ordering. Basis, at-risk, passive loss, and then section 461(l), each with its own calculation.
• NOL tracker. The carryover from section 461(l) by year, matched to the Form 172 schedule.
• Year-over-year bridge. For clients who had full deductions in 2025, a comparison of the $313,000 and $256,000 non-joint thresholds, or the joint equivalents, so the client sees why the 2026 return carries a disallowance.

Related reading includes the QBI deduction after the 2025 legislation, because the excess business loss computation ignores the section 199A deduction, and Section 179 and bonus depreciation, since depreciation deductions feed directly into the loss. For entity-level choices, see S corporation vs LLC. For the 2026 estimates that depend on these results, see estimated tax safe harbors.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• Cornell Law School Legal Information Institute, 26 U.S.C. 461: https://www.law.cornell.edu/uscode/text/26/461
• U.S. Government Publishing Office, Public Law 119-21, section 70601: https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm
• Internal Revenue Service, Instructions for Form 461: https://www.irs.gov/instructions/i461
• Internal Revenue Service, Internal Revenue Bulletin 2025-45 (Rev. Proc. 2025-32, section 4.31): https://www.irs.gov/irb/2025-45_IRB

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