In 2025, Congress enacted the One, Big, Beautiful Bill Act (OBBBA), making permanent the limitation on excess business losses (EBLs). This change reshapes how taxpayers use business losses in their overall planning. For investors in TALS™ limited partnerships (LPs), understanding how losses interact with EBL, passive activity loss (PAL) rules, and net operating losses (NOLs) is essential. While these rules may defer part of the benefit, they do not erase it. This article explains how TALS™ LPs work, how swaps and trader status affect tax treatment, and how EBL, PAL, and NOL rules play out in practice.
Key Takeaways
- EBL is now permanent. Thanks to the OBBBA, the limitation on excess business losses will not expire [4].
- TALS™ LP losses are business losses. Because of the trader fund status, they are not passive and therefore bypass the PAL rules.
- Losses are deferred, not eliminated. Any amount disallowed by EBL converts into NOLs, preserving their tax benefit for future years.
- NOLs apply broadly. Once created, they may offset most forms of income, subject to the 80% limitation [8].
- Coordination is essential. Business losses across different activities are aggregated when applying the EBL test, so outcomes depend on the whole picture of a taxpayer’s financial life.
What Is TALS™?
TALS™ stands for Tax-Aware, Long-Short Investment & Tax Strategies. It represents a category of investment approaches that aim to combine sophisticated portfolio management with equally sophisticated tax strategies. In practice, this means designing strategies that do not simply pursue higher returns but do so in a way that enhance the investor’s after-tax wealth. Long-short trading, harvesting gains and losses, utilizing specific types of investments, and structuring the portfolio for after-tax efficiency are common features of these approaches.
TALS™ strategies generally come in two formats:
- A separately managed account (SMA), structured as a brokerage account that issues a Form 1099 annually.
- A limited partnership (LP) interest, which issues a Schedule K-1 annually.
The TALSTM SMA format is generally restricted to SEC Accredited Investors, while the LP format is available to SEC Qualified Purchasers. In practice, these two formats are often used together, allowing investors to coordinate ordinary and capital income streams for optimal after-tax outcomes.
In a TALS™ LP investors participate in a professionally managed investment partnership where trading decisions are made to pursue returns and increase wealth but with tax sensitivity in mind. What distinguishes TALS™ LP for tax purposes is that it has structured and managed to qualify as a trader in securities under §162, consistent with IRS guidance and case law (e.g., Chen v. Commissioner and Endicott v. Commissioner), which classifies its activities as a trade or business. This status matters because it changes how gains and losses flow through to investors and determines whether certain limitations, like the passive activity rules, apply [1][10][11].
Additionally, TALS™ LP managers often use swaps as their primary investment vehicle. Equity swaps replicate the economics of owning a stock but carry different tax attributes. When combined with strategic use of swaps in a tax-aware trading program, these attributes can yield favorable results for the LP or investor. This may include business losses that can be utilized to offset both business and non-business income, yielding significant tax savings, albeit subject to limitations discussed below.
How TALS™ LPs Use Swaps
A common tool within Tax-Aware, Long-Short LPs is the use of monthly reset total return swaps, which fall under the IRS category of notional principal contracts (NPCs) [13]. These instruments are structured so that the investor receives or pays the total return of an underlying stock or index—including price appreciation and dividends—without directly owning the security. Economically, this makes the swap behave much like owning the stock itself, but with cash flows exchanged between counterparties at each reset.
From a tax standpoint, Treasury Regulations provide for three categories of NPC payments [14]:
- Periodic payments (such as monthly resets) are recognized in the year they relate to and treated as ordinary income or loss.
- Nonperiodic payments (such as upfront or contingent payments) are spread over the term of the contract and also treated as ordinary income or loss.
- Termination payments (when a swap is closed out early or exchanged for another contract) are generally ordinary, but if the NPC is held as a capital asset, the resulting gain or loss may be characterized as capital [15].
Because of these rules, NPC transactions can produce ordinary income or loss, capital gain or loss, or a combination thereof [15]. This framework is why some funds disclose that their swap activity may give rise to both capital and ordinary character.
This opens the door to what practitioners sometimes call character arbitrage [16]:
- If a position is at a loss, letting the swap reset ensures that the loss is realized as an ordinary loss, potentially offsetting wages, interest, or other ordinary income (subject to the excess business loss limitation).
- If a position is at a gain, terminating before reset may allow the gain to be characterized as a short-term capital gain, which is grouped with other capital transactions.
In practice, K-1s from trader funds often show a mix of Box 8 short-term capital gains and Box 11 ordinary swap income/loss. This reflects how managers structure their trading and reporting. While the approach can improve tax efficiency, it is best understood as using the mechanics of different instruments within the NPC framework to influence whether gains and losses show up as capital or ordinary.
Excess Business Loss Limitations
The Internal Revenue Code allows taxpayers to deduct business losses, but with restrictions. The excess business loss limitation, first introduced by the Tax Cuts and Jobs Act of 2017, prevents taxpayers from deducting unlimited amounts of business losses against non-business income [2]. For the 2025 tax year, the thresholds are:
- $313,000 for single filers [3]
- $626,000 for joint filers [3]
Losses in excess of these amounts are labeled as excess business losses. Rather than being deducted immediately, they are carried forward as Net Operating Losses (NOLs) to future tax years. Importantly, this does not mean the losses disappear — they are deferred, not lost.
The OBBBA, enacted in 2025, made this limitation permanent. Originally set to expire, the EBL rule is now a fixed feature of the tax code [4]. This permanence means taxpayers and their advisors must assume the EBL cap will apply every year, allowing for continued and potentially significant tax benefits from tax-aware strategies like TALS™ but also cementing the need for a multi-year tax-planning approach that thoughtfully considers EBL and related rules and limitations.
Passive Activity Losses (PALs)
Another limitation often confused with the EBL is the passive activity loss (PAL) limitation. Under §469, losses from passive activities can only offset passive income; any excess is suspended and carried forward. This rule is designed to prevent taxpayers from sheltering wages or portfolio income with passive losses.
Why TALS™ LPs Are Not Passive: Because Tax-Aware, Long-Short LPs are structured and operated to qualify as traders in securities under §162, consistent with IRS guidance and case law, their activities are treated as an active trade or business, not a passive activity. As a result, their gains and losses are not subject to the PAL limitation. Instead, they flow through as business income or loss, subject only to the EBL rules.
Comparison with Real Estate Strategies:
- In real estate, taxpayers often face the PAL rules directly. For example, short-term rental strategies or attaining Real Estate Professional Status (REPS) can allow individuals to escape PAL restrictions and potentially take deductions against ordinary income, but these require meeting strict material participation and annual hour thresholds.
- By contrast, investors in TALS™ LPs do not need to meet such participation tests; the structure itself ensures the activity is classified as business, not passive.
This distinction underscores why TALS™ LPs can be particularly powerful in a diversified tax strategy: they produce ordinary business income and losses that interact directly with EBL and NOL rules, without being trapped by PAL limitations.
How Net Operating Losses (NOLs) Work
When business losses exceed the EBL limitation, the excess does not disappear. Instead, it becomes a Net Operating Loss (NOL) that carries forward to future years. Under current law, NOLs may offset up to 80% of taxable income in each carryforward year [8]. There is no expiration date — they may be carried forward indefinitely until fully used. This ensures that while deductions are limited in the current year, taxpayers can still capture the benefit of those losses over time, smoothing out the tax impact of volatile income streams.
Character of Income When Applying NOLs
When applying an NOL carryforward, the character of the income does not matter. An NOL is a general tax attribute that offsets taxable income broadly. Whether income comes from wages, business profits, dividends, interest, or capital gains, the NOL can reduce it, subject to the 80% limitation [9].
An Illustrative Example
Consider a married couple filing jointly in 2025:
- They have $300,000 in W-2 wage income.
- They have $700,000 in operating K1 Income.
- They realize $500,000 of Roth conversion income.
- Their TALS™ LP investment produces a $2,000,000 ordinary loss.
- The TALS™ LP also generates $2,000,000 in short-term capital gains.
- Separately, a TALS™ SMA is managed to realize $2,000,000 in short-term capital losses.
Total K1 Income before the TALS™ LP loss is $700,000. The $2,000,000 ordinary loss from the TALS™ LP more than offsets this, leaving a net business loss of $1,300,000. Under the excess business loss (EBL) rules [2], the couple may deduct up to $626,000 of business losses for 2025. This allowed loss offsets all $300,000 of W-2 wages and $326,000 of the Roth conversion income, leaving $174,000 of Roth conversion taxable. The remaining $674,000 of disallowed loss is carried forward as part of a Net Operating Loss (NOL) [8].
Year 1 Summary
| Category | Income/(Loss) | Tax Treatment | Current Year Impact |
| W-2 Income | $300,000 | Ordinary | Fully offset |
| Business K1 Income | $700,000 | Ordinary | Fully offset |
| Roth Conversion Income | $500,000 | Ordinary (non-business) | $326,000 offset, $174,000 taxable |
| TALS™ LP Ordinary Loss | ($2,000,000) | Ordinary (subject to EBL) | $626,000 allowed, $674,000 disallowed → NOL |
| TALS™ LP ST Capital Gain | $2,000,000 | Short-Term Capital Gain | +$2,000,000 |
| TALS™ SMA ST Capital Loss | ($2,000,000) | Short-Term Capital Loss | -$2,000,000 |
Net Result 2025: $174,000 taxable ordinary income (from Roth conversion). $674,000 carried as NOL. Capital gains net to $0.
Continuing the Example: Year 2
In 2026, assume the couple has:
- $300,000 in W-2 wage income.
- $700,000 in operating K1 Income.
- No Roth conversion income.
- No income or loss from the TALS™ LP.
- No capital gains or losses from TALS™ strategies.
From 2025, they carry forward $674,000 of Net Operating Loss (NOL). Under current law, NOLs may offset up to 80% of taxable income [8].
Ordinary Income in 2026:
- Total ordinary income = $1,000,000 ($300,000 W-2 + $700,000 K1).
- NOL available = $674,000.
- NOL limit (80% of $1,000,000) = $800,000.
- Entire $674,000 NOL can be applied.
Result:
- Taxable ordinary income after NOL = $326,000.
- Remaining NOL carried forward = $0.
Year 2 Summary
| Category | Income/(Loss) | Tax Treatment | Current Year Impact |
| W-2 Income | $300,000 | Ordinary | Included in $1,000,000 total |
| Business K1 Income | $700,000 | Ordinary | Included in $1,000,000 total |
| Prior Year NOL Carryforward | ($674,000) | NOL offset (80% cap test) | $674,000 applied |
Net Result 2026: $326,000 taxable ordinary income. NOL fully used.
Federal Tax Savings
Using the 2025 federal tax brackets for married filing jointly:
- Year 1 (2025): Without TALS™ losses, taxable income would have been $1,500,000, resulting in approximately $499,123 of federal income tax [3]. With TALS™ LP losses and EBL limitations applied, taxable income was reduced to $174,000, with tax of approximately $29,963. Tax savings: about $469,160.
- Year 2 (2026): Without the NOL, taxable income would have been $1,000,000, with tax of approximately $296,123[3]. After applying the NOL carryforward, taxable income was reduced to $326,000, with tax of approximately $63,863. Tax savings: about $232,260.
Together, these two years demonstrate how losses from TALS™ LP, though limited in Year 1, preserve tax benefits for future years through the NOL carryforward, significantly reducing overall federal tax liability.
Why This Matters for Investors
Understanding how TALS™ LP interacts with the EBL limitation helps investors set realistic expectations. In years when losses are large, EBL may defer part of the tax benefit. In years with smaller losses or offsetting gains, more may be absorbed immediately. Either way, the economic value of the losses remains intact.
This broader framework also demonstrates the complexity of aligning investment strategies with tax law. Choosing investment vehicles structured as trader funds offers a way to avoid the additional hurdle of passive activity loss rules, though the EBL limitation still applies. For investors seeking long-term, tax-aware strategies, it is essential to understand not just what happens in the portfolio, but also how the tax code channels and times the recognition of results.
When reviewing this material with an advisor, consider asking:
- How does the investment fit into and affect my overall investment allocation? What changes should I consider?
- Can you handle this level of sophisticated tax planning on a short and long-term basis?
- How will my projected non-business income and K1 income interact with TALS™ LP losses under the EBL rules?
- Should I coordinate Roth conversions or other income recognition strategies with potential EBL and NOL usage?
- Can you accurately prepare and file the complex 1099 and K1 tax forms associate with Tax-Aware, Long-Short Tax & Investment Strategies™?
- How might TALS™ SMA strategies be paired with LP investments to balance capital and ordinary outcomes? (Note: this was not discussed in any detail in this article but is critically important to avoid poor tax outcomes.)
- How many TALS™ implementations have you done for clients and how have they varied?
- Why did you select the TALS™ investment managers you did?
Conclusion
The OBBBA has reshaped the landscape by making the excess business loss limitation a permanent part of tax law. For participants in TALS™ LP, this means recognizing that their losses are business losses subject directly to the EBL limitation. While this can defer deductions beyond the $313K/$626K thresholds, the losses are preserved as NOLs and continue to provide value in future years.
In short, the fact that TALS™ LPs are structured to qualify as traders in securities under §162 ensures that their activity avoids passive loss restrictions, but the EBL limitation remains a defining feature of the tax treatment. Understanding these dynamics equips investors to better anticipate outcomes, align their expectations, and appreciate how sophisticated strategies like TALS™ operate within the realities of the tax code.
Kevin Kroskey, CFP®, MBA, is the Founder of True Wealth Design, which provides “Accounting, Tax & Wealth Solutions To Help You Plan Smarter and Live Better.” This article is for educational purposes only. The strategies referenced apply to Accredited Investors or Qualified Purchases per SEC regulations.
PS: If you’re ready to explore a relationship and avail yourself of our sophisticated tax and investment strategies, use this link to schedule a free 20-minute call with one of our highly experienced and credentialed professionals.
Frequently Asked Questions (FAQs)
What is the Excess Business Loss limitation for 2025?
For joint filers it is $626,000 and for single filers $313,000 (adjusted annually)²³.
Are TALS™ LP losses passive?
No. Because TALS™ LPs are structured to qualify as traders in securities under §162, their losses are business losses, not passive.
Do TALS™ LP investors need to worry about PAL rules?
Not directly, but PAL rules matter for other investments (like rental real estate). By contrast, TALS™ LPs produce business income or losses subject to the EBL rules.
Can NOLs offset all income?
No. Since 2018, NOLs may offset up to 80% of taxable income each year⁸.
Sources
- IRS Publication 550, Investment Income and Expenses (2024)
- Internal Revenue Code §461(l)
- IRS Revenue Procedure 2024-25, Inflation Adjusted Amounts for 2025
- Congressional Research Service, Excess Business Loss Limitation and OBBBA Permanence (2025)
- IRS Publication 925, Passive Activity and At-Risk Rules
- Internal Revenue Code §172
- IRS Chief Counsel Memorandum AM 2020-003 (treatment of trader funds)
- Internal Revenue Code §172(a)(2)
- IRS Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
- IRS Topic No. 429, Traders in Securities (Information for Form 1040 Filers)
- Chen v. Commissioner, T.C. Memo 2004-132
- Endicott v. Commissioner, T.C. Memo 2013-199
- Treasury Regulation §1.446-3(d), (g), (h)(2), Notional Principal Contracts (1994)
- Treasury Regulation §1.446-3(h), Termination and Periodic Payments under NPCs (1994)
- KPMG, Schedule K-1 Supporting Statements for QFAF LP (2022)
- Dougherty, Michael S., How to Modify the Taxation of Notional Principal Contracts to Eliminate the Whipsaws on Both Sides, Journal of Taxation of Investments
Related Podcasts
Part 1: The Long and Short on Tax-Aware, Long-Short (TALS) Investing – True Wealth Design
Part 2: The Long and Short on Tax-Aware, Long-Short (TALS) Investing – True Wealth Design
Part 3: The Long and Short on Tax-Aware, Long-Short (TALS) Investing – True Wealth Design
