What is a Net Operating Loss (NOL)?
A net operating loss (NOL) results from the situation in which a business or individual has more allowable tax deductions than it has taxable income. In this case, the business has negative income or a net operating loss. That's the bad news. But the good news is that you may be able to take that net operating loss and move it to a future tax year (or years) in which you had a profit (actually, net operating income).
To have an NOL, your loss must generally be caused by deductions due to expenses from:
- A business (but see restrictions on losses depending on types of business below)
- Your work as an employee
- Losses due to casualties or theft
- Moving expenses
- Rental property
Most net operating losses are related to business losses. To be considered, these business losses must be included on the owner's individual tax return. The net operating loss, therefore, is applicable only to certain pass-through businesses, specifically sole proprietorships and single-member LLCs.
The IRS says that generally partnerships and S corporations cannot claim net operating losses, but the individual partners or S corp owners can figure their share of the loss on their individual tax returns. A net operating loss for corporations is a different type of loss, not included in this article.
Some business expenses cannot be used to calculate a net operating loss. For example, losses from home business expenses are limited to those that offset income. In other words, if your loss for a home business is $10,000 and you only have $5,000 of income (before deductions), you can only claim a net operating loss of $5,000.
Net operating losses incurred in connection with bankruptcies are not included in this article.
What to Do If You Have a Net Operating Loss
Here's an overview of the process of finding and taking a net operating loss:
- First, complete your personal tax return (including Schedule C for your business, if applicable) to get to Line 31, your business net income.
- Then you must exclude specific items on your tax return to make sure you can include everything. You will need to calculate the exact amount of the net operating loss for that year.
- Then, you can calculate the amount that can be carried forward to a previous tax year. The carry forward amount for any one year is limited to 80 percent of taxable income (determined without regard to the deduction).
Calculating the Net Operating Loss
The loss from your business is only one part of the net operating loss calculation. You will also need to complete your tax return to get a calculation of your total Adjusted Gross Income for the year.
Other information you need to calculate NOL includes:
- Nonbusiness capital gains and losses (from investments, for example
- Nonbusiness deductions, like alimony paid, deductions for IRA contributions or a self-employed retirement plan,
- Nonbusiness income, including taxable IRA contributions, dividends and interest on investments, pension and Social Security benefits.
To see the specific calculations for Net Operating Loss, refer to Worksheet 1 in IRS Publication 536: (2018), Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.
Carrying Forward a Loss to Minimize Taxes
A net operating loss in one year can be used to minimize tax profits in one or more years.
Net operating losses may be carried forward (used to offset profits in future years) depending on IRS regulations in effect at the time of the loss. There is a specific process for doing the carry forward calculation.
As you can see from this brief discussion, the process of determining, calculating, and moving the net operating loss is complicated. The IRS has limits and restrictions on this process and the amounts you can carry forward. If you think you have a net operating loss and you want to use it to reduce taxes, get the help of a tax professional.