What Is Net Operating Loss?
A net operating loss (NOL) is when an individual or business’s annual tax deductions are greater than their adjusted gross income.
This may seem like a negative situation, as one of the main goals of a business is to make a profit, but a net operating loss can actually have some positive tax implications, such as a net operating loss carryforward and in certain circumstances a net operating loss carryback.
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Net Operating Loss Definition
A net operating loss is when an individual or business’s allowable annual tax deductions are greater than their adjusted gross income, or taxable income. So, essentially, instead of turning a profit, the entity “lost” money for the year. The amount of this loss can then be used to reduce future tax burden.
How to Calculate Net Operating Loss
You can calculate a NOL by subtracting allowable itemized deductions from adjusted gross income. Managing a business’s financial books can be complicated if you don’t have the right resources. We recommend using dedicated accounting software to ensure that you are keeping accurate records. To that end, we compiled a list of the Best Accounting Software for Small Businesses.
It is important to know which expenses do and do not count toward calculating a NOL. The US Internal Revenue Service (IRS) allows the following types of deductions when calculating a NOL:
- Trade or business losses
- Rental property
- Casualty and theft losses resulting from a federally declared disaster
Additionally, the following are allowable under certain circumstances, but not for most taxpayers for 2018 through 2025:
- Moving expenses
- Work as an employee
The following do not count toward calculating a NOL:
- Capital losses in excess of capital gains.
- Section 1202 exclusions of the gain from the sale or exchange of qualified small business stock.
- Nonbusiness deductions in excess of nonbusiness income.
- The NOL deduction itself
- The section 199A deduction for qualified business income.
- The section 199 deduction for income attributable to domestic production activities
Once you have added up all your allowable deductions, subtract that amount from your adjustable gross income. If the resulting amount is negative, you have a NOL.
Read more about deductions with our What Are Tax-Deductible Business Expenses? guide.
How Does Net Operating Loss Work With Taxes?
First, it is a good idea to familiarize yourself with the tax basics. We have put together this LLC Tax Guide to help with that.
The rules about the tax options for net operating losses have changed multiple times in recent years. The following is the most up-to-date information about NOL deductions, carryforwards, and carrybacks.
Net Operating Loss Deduction
A NOL deduction is the amount of a NOL that is deducted from a different year’s tax liability. A NOL deduction can apply to future tax years, which is called a carryforward, or in some cases to past tax years, called a carryback.
Net Operating Loss Carryforward
A NOL carryforward is when an entity takes a NOL and applies it to future tax years to reduce its tax liability. Prior to the Tax Cuts and Jobs Act of 2017, there was a 20-year limit on the period during which a NOL could be carried forward and deducted from tax liability, but the new law removed that time limit. The NOL carryforward time period is now indefinite.
It is important to note that the NOL deduction cannot be greater than 80% of an entity’s taxable income in any given year. If the total NOL exceeds that amount, the remainder will have to be applied to other tax years.
Net Operating Loss Carryback
A NOL carryback is when an entity applies a net operating loss to past tax payments, resulting in a tax refund. While this was a popular option for many entities with a NOL in years past, the Tax Cuts and Jobs Act of 2017 eliminated this option for most entities (certain farming businesses and insurance companies were still permitted to use carrybacks).
However, the 2020 CARES Act changed the rule to allow net operating loss carryback for a specific period of time. Under the new law, a NOL generated in a taxable year beginning after December 31, 2017, and before January 1, 2021, can be carried back five years. The rule also allows NOLs recorded in the 2017 fiscal year to be carried back two years.
Net Operating Loss Forms
When claiming a NOL deduction carryforward on a personal tax return, such as when filing taxes for pass-through entities like a limited liability company (LLC) or sole proprietorship, list the amount on the "Other income" line of Schedule 1 (Form 1040 or Form 1040-SR) or Form 1040-NR.
When permitted to claim a net operating loss carryback, you can use Form 1045 or Form 1040-X. Form 1045 is generally used when filing for a carryback within one year of the tax period, whereas Form 1040-X is used when filing later.
Frequently Asked Questions
What is a net operating loss deduction?
A net operating loss deduction is the amount of a net operating loss that is deducted from a different year’s tax liability.
Can net operating losses be carried back?
The 2020 CARES Act allows net operating loss carryback for a specific period of time. A net operating loss generated in a taxable year beginning after December 31, 2017, and before January 1, 2021, can be carried back five years. The rule also allows net operating losses recorded in the 2017 fiscal year to be carried back two years.
How do I claim a net operating loss?
When claiming a net operating loss deduction carryforward on a personal tax return, such as when filing taxes for an LLC or sole proprietorship, list the amount on the "Other income" line of Schedule 1 (Form 1040 or 1040-SR) or Form 1040-NR.
How does NOL carryforward work?
A NOL carryforward is when an entity takes a net operating loss and applies it to future tax years to reduce its tax liability. The net operating loss carryforward time period is indefinite. The net operating loss deduction cannot be greater than 80% of an entity’s taxable income in any given year. If the total net operating loss exceeds that amount, the remainder will have to be applied to other future tax years.
How far can you carry losses back?
The 2020 CARES Act allows net operating losses incurred in a taxable year beginning after December 31, 2017, and before January 1, 2021, to be carried back five years.
How many years can a corporation carry forward a net operating loss?
A NOL can be carried forward indefinitely.
