On July 27, Senate Republicans released their proposal for the next pre-election round of pandemic stimulus legislation. The HEALS Act, which comprises eight smaller bills, represents the Republican response to the House Democrats’ HEROES Act, which passed the lower chamber in mid-May. The differences between these two legislative projects are legion. One such difference involves the “excess business loss” rules in § 461(l)—a matter of particular concern to certain taxpayers, lobbyists, affinity groups, and their elected representatives, as well as recent scholarly work by Steven Hodaszy and Clint Wallace.
The next two paragraphs offer a brief synopsis of § 461(l), omitting most of the social and political context but including many of the eye-glazing technical bits. In December 2017, the legislation known as the Tax Cuts and Jobs Act added § 461(l) to the Internal Revenue Code, presumably as a revenue offset for a miniscule portion of the law’s mammoth tax cuts. As enacted, § 461(l) disallowed certain single-year business losses that exceeded $250,000 or $500,000 for single individuals and joint filers, respectively. This limitation applied after the passive activity loss rules in § 469 and the at-risk rules in § 465, and any excess loss was rolled into subsequent years’ net operating loss carryforwards under § 172, as modified by the TCJA. Two items of note: this version of § 461(l) applied to a relatively small number of relatively well-off taxpayers, and a number of commentators interpreted § 461(l) as targeting the real estate sector.
This spring, the CARES Act largely deferred § 461(l)’s application until 2021. This change was retroactive for 2018 taxable years (amended returns!) and prospective for 2020 taxable years (estimated tax payments!). For 2019, the change’s effects are less easily categorized, since many beneficiaries likely hadn’t filed when the CARES Act was signed. The HEROES Act would undo the CARES Act’s suspension of § 461(l), while leaving in place certain other revenue-raising changes to § 461(l) implemented by that law. Wallace generally supports HEROES Act-type changes and opposes the “unlimited pass-through deduction” allowed by the CARES Act. By contrast, the HEALS Act wouldn’t touch the CARES Act changes to § 461(l). Hodaszy generally supports the CARES Act changes and would prefer to repeal § 461(l) in its entirety. In short, Hodaszy and Wallace don’t agree, and they each have their good and valid reasons.
Underlying Hodaszy and Wallace’s relatively focused disagreement, I think, are echoes of a broader disjuncture among certain camps of tax lawyers, academics, and policymakers. Perhaps unsurprisingly, taxpayers tend to understand benefits conveyed through the Code as crucial incentives intended by Congress, while reading any concomitant detriments as pernicious deviations from sacrosanct normative principles, such as an ideal income tax base. From this perspective, the TCJA’s expensing rules are great, while limitations on using the resulting deductions—such as § 461(l)—are terrible. Some agree with these taxpayers’ views, perhaps with too little critique. Others reject them, perhaps with too little consideration. Setting up this binary is, of course, itself reductive of the communities characterized, and neither Hodaszy nor Wallace succumbs to either extreme. But nostalgic strands of this dialectic are latent in Hodaszy’s reverence for a Surrey-esque definition of income (notwithstanding the Code’s plethora of loss limitations) and Wallace’s complaints about “how tax policy is made in Congress these days” (notwithstanding the sausage-making processes of yore). Hodaszy and Wallace each make important policy points, but they both occasionally seem to just want the kids to get off their yard, posthaste. In this environment, it’s harder to see intermediate positions, even if those positions might work better than pure repeal or pure reinstatement.
Alternative framings might yield more nuanced solutions. For example, Wallace notes that the CARES Act’s suspension of § 461(l) releases cash tax benefits that “are not conditioned on taking future actions or using the funds received in a way that might have positive spillover effects.” Other CARES Act programs impose myriad specific requirements on the receipt or use of relief funds; tax refunds are unrestricted and can be diverted or pocketed freely. Hodaszy argues that the suspension of § 461(l) “will enable [owner-operators] to infuse their struggling businesses with funds,” but this conclusion is not foregone, especially for pass-through businesses. The use of these funds—JCT pegs the amount at $135 billion—represents the true policy stakes of modifying § 461(l), from a stimulus perspective. And this framing may open a middle ground in debates over the provision. (As an aside, a parallel argument about use of funds provides the best justification for Notice 2020-32, which denies business expense deductions traceable to the proceeds of forgiven Paycheck Protection Program loans.)
Furthermore, § 461(l) operates in conjunction with numerous other business tax base provisions, most notably § 172. After the TCJA tightened taxpayers’ abilities to use net operating losses under § 172, the CARES Act loosened those restrictions by instituting a five-year carryback for NOLs arising in 2018, 2019, and 2020. There are strong normative reasons for permitting NOL carrybacks, particularly in an economic downturn when they can function as automatic-ish stabilizers. The CARES Act, however, allows taxpayers to carry NOLs that accrue post-TCJA back to the higher-rate world before 2018. The suspension of § 461(l) somewhat mitigates this rank form of rate arbitrage by increasing current-year losses and reducing the amount of losses that become NOLs. Had the CARES Act not suspended § 461(l), a 2018 excess business loss would have produced a dollar-for-dollar NOL that, under modified § 172, could have generated a bigger refund from a higher-rate, pre-2018 taxable year. So there’s a technical, coordination-oriented reason to suspend § 461(l)—and the suspension also arguably is progressive, since it may result in smaller tax refunds for well-off taxpayers! Of course, there are other reasonable solutions: the HEROES Act would preclude carrybacks to 2017 and earlier, which makes reinstating § 461(l) more appropriate. But these structural or interaction-oriented considerations should loom larger in evaluating changes or potential changes to § 461(l).
Overall, Hodaszy and Wallace’s respective articles are timely and important contributions to current debates about pandemic relief. Policymakers, as well as academics should attend to their perspectives as the next round of stimulus (hopefully, fingers crossed) takes shape.