At-Risk Activities: Definition and Tax Implications
Definition of At-Risk Activities
At-risk activities are those that involve the potential for financial losses (Investopedia, n.d.). These losses can be claimed as deductions for tax purposes, subject to certain limitations.
At-Risk Rules as Tax Shelter Laws
At-risk rules are tax shelter laws that restrict the amount of deductions individuals or closely held corporations can claim for losses incurred in at-risk activities (Investopedia, n.d.). These rules were enacted to prevent taxpayers from abusing tax shelters to reduce their tax liability.
Scope of At-Risk Rules
At-risk rules apply to all trades or businesses and other income-producing activities (IRS, 2022). This includes passive activities, which are activities that do not involve active participation by the taxpayer.
Applicable Entities
At-risk rules apply to the following entities:
Key Facts
- Definition: At-risk activities are activities that have the potential to generate financial losses, which can be claimed as deductions for tax purposes.
- Tax Shelter Laws: At-risk rules are tax shelter laws that restrict the amount of deductions individuals or closely held corporations can claim for losses incurred in at-risk activities.
- Scope: At-risk rules apply to all trades or businesses and other income-producing activities.
- Applicable Entities: At-risk rules apply to individuals, estates, trusts (except grantor trusts), personal service corporations, and closely held corporations.
- Passive Activity Limits: At-risk rules are closely related to passive activity rules, which limit the deductibility of losses from passive activities.
- Disallowed Deductions: If a taxpayer incurs losses from at-risk activities, a portion of those losses may be disallowed and subject to allocation among different passive activities and deductions within a passive activity.
- Carryover of Disallowed Deductions: Disallowed deductions from at-risk activities can be carried over to the next tax year and allocated among activities that continue the loss activity.
- Passive Activity Credit: Generally, the passive activity credit is disallowed under at-risk rules.
- Publicly Traded Partnerships: At-risk rules also apply separately to income or loss from passive activities held through publicly traded partnerships (PTPs).
- Former Passive Activities: Former passive activities, which were passive in previous tax years but are not passive in the current tax year, have specific treatment under at-risk rules.
- Individuals
- Estates
- Trusts (except grantor trusts)
- Personal service corporations
- Closely held corporations (IRS, 2022)
Relationship to Passive Activity Rules
At-risk rules are closely related to passive activity rules, which limit the deductibility of losses from passive activities (IRS, 2022). Passive activities are generally defined as activities in which the taxpayer does not materially participate.
Disallowed Deductions
If a taxpayer incurs losses from at-risk activities, a portion of those losses may be disallowed and subject to allocation among different passive activities and deductions within a passive activity (IRS, 2022).
Carryover of Disallowed Deductions
Disallowed deductions from at-risk activities can be carried over to the next tax year and allocated among activities that continue the loss activity (IRS, 2022).
Passive Activity Credit
Generally, the passive activity credit is disallowed under at-risk rules (IRS, 2022).
Publicly Traded Partnerships
At-risk rules also apply separately to income or loss from passive activities held through publicly traded partnerships (PTPs) (IRS, 2022).
Former Passive Activities
Former passive activities, which were passive in previous tax years but are not passive in the current tax year, have specific treatment under at-risk rules (IRS, 2022).
Conclusion
At-risk rules are an important part of the tax code that help to prevent taxpayers from abusing tax shelters to reduce their tax liability. These rules apply to a wide range of activities and entities, and they can have a significant impact on the deductibility of losses.
References
- Internal Revenue Service. (2022). Publication 925: Passive Activity and At-Risk Rules. https://www.irs.gov/publications/p925
- Investopedia. (n.d.). At-Risk Rules: Definition, Basis Calculation, Example. https://www.investopedia.com/terms/a/atriskrules.asp
- Journal of Accountancy. (2019). The at-risk rules for partnerships. https://www.journalofaccountancy.com/issues/2019/jun/partnership-at-risk-rules.html
FAQs
What is an at-risk activity?
An at-risk activity is any activity that has the potential to generate financial losses, which can be claimed as deductions for tax purposes.
What are the at-risk rules?
The at-risk rules are tax shelter laws that restrict the amount of deductions individuals or closely held corporations can claim for losses incurred in at-risk activities.
Who is subject to the at-risk rules?
The at-risk rules apply to individuals, estates, trusts (except grantor trusts), personal service corporations, and closely held corporations.
What are the consequences of violating the at-risk rules?
If a taxpayer violates the at-risk rules, a portion of their losses may be disallowed and subject to allocation among different passive activities and deductions within a passive activity.
Can disallowed losses be carried over to future years?
Yes, disallowed losses from at-risk activities can be carried over to the next tax year and allocated among activities that continue the loss activity.
Do the at-risk rules apply to passive activities?
Yes, the at-risk rules apply to passive activities, which are activities in which the taxpayer does not materially participate.
Do the at-risk rules apply to publicly traded partnerships?
Yes, the at-risk rules apply separately to income or loss from passive activities held through publicly traded partnerships (PTPs).
How do the at-risk rules affect former passive activities?
Former passive activities, which were passive in previous tax years but are not passive in the current tax year, have specific treatment under the at-risk rules.