A net operating loss (NOL) occurs when a business or individual has more allowable tax deductions than taxable income. In other words, the business has a negative income. Depending on a business's situation, it may be able to take a net operating loss and move it to a future tax year (or years) in which it had a profit (net operating income), thereby reducing its tax burden.
Here's what you need to know to claim a net operating loss.
CARES Act (2020) Changes in Net Operating Losses
The CARES Act of 2020 has made some changes in net operating loss procedures to help businesses affected by the economic downturn.
The 2017 tax law had disallowed tax loss carrybacks to previous years. The CARES Act removes that restriction for carryback of losses in tax years beginning after Dec. 31, 2017, and before Jan. 1, 2021, to each of the five taxable years before the tax year of the loss.
Taxpayers can waive the carryback period for NOLs in tax years 2018, 2019, and 2020.
The Internal Revenue Service (IRS) announced in April 2020 that eligible refund claims for carryback of net operating losses under the CARES Act described above can be faxed to the IRS. This is a temporary measure starting on April 17, 2020, until further notice.
Claims on IRS Form 1139 can be submitted to this fax number: 844-24--6236
Claims on IRS Form 1145 can be submitted to this fax number: 844-249-6237
These new relief measures are complicated. Get help from your tax professional before you attempt to take a net operating loss carryback for the 2019 tax year or before.
What Is Net Operating Loss?
A net operating loss is a situation in which an entity's annual tax deductions are worth more than that company's adjusted gross income (AGI). This initially seems like a negative scenario—and it may not be sustainable—but there are tax advantages to a net operating loss.
Instead of taking all those deductions on the year of the net operating loss, a business may save some of those deductions for a year when it doesn't have a net operating loss, effectively decreasing its tax bill in the otherwise profitable year.
Net operating losses may occur with businesses, individuals, estates, or trusts.
How Do You Calculate Net Operating Loss?
To calculate your net operating loss, subtract your deductions from your AGI.
How Net Operating Losses Work
While different entities can claim an NOL, there are limitations on the types of deductions that can be factored into the equation. 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
Certain types of losses and deductions are generally excluded from the NOL calculation, including:
- Capital losses (from investments or sale of business assets)
- Nonbusiness losses
- Section 199A (Qualified Business Income) deduction
Most net operating losses are related to business losses. To take the loss, you must include it on your personal tax return. The net operating loss, therefore, applies 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.
Corporations can also have a net operating loss, but this loss doesn't affect individual owners (shareholders). See IRS Publication 542 Corporations for more information.
Information Needed to Figure a Net Operating Loss
To figure your net operating loss you will need (in addition to your Form 1040 and other schedules):
- IRS Publication 536 Net Operating Loss (NOLs) for Individuals Estates and Trusts (the worksheet on Page 3)
- IRS Form 1040 Schedule D (if you have a capital gain or loss)
Your business tax report is included on your personal tax return through:
- Schedule C for a sole proprietorship or single-member LLC
- Schedule K-1 for your income as an S corporation shareholder, partner in a partnership, or member of a multiple-member LLC
Steps in Figuring a Net Operating Loss
First, complete your tax return for the year, including your business income or loss.
Next, check to see if you have an NOL by using the formula listed above and IRS worksheets.
At this point, if you have large losses, you may need to calculate excess loss limits. Before you do this calculation, you must apply other limits on business losses, specifically the at-risk limits and passive activity limits. Then, you would use the worksheets in IRS Publication 536 to calculate the amount of the excess NOL.
If your net operating loss deduction is over $18,000 for the year, you can't take the excess loss in this year, but you may be able to carry over the excess to a future year.
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.
The process of calculating a carryforward for a net operating loss depends on which year you are carrying it to and whether you had previous years carryovers. See IRS Publication 536 on Net Operating Losses.
As you can see from this brief discussion, the process of determining, calculating, and carrying over a net operating loss is complicated. The IRS has limits and restrictions on this process and the amounts you can carry forward and the calculations are daunting. Get the help of a tax professional if you think you have a net operating loss and you want to use it to reduce taxes.
Limitations of Net Operating Losses
The 2017 Tax Cuts and Jobs Act made changes to net operating loss calculations and limits beginning in 2018 and beyond. The CARES Act has changed some of these limits for certain years, but the limits may resume after CARES Act changes end.
No NOL Carryback Allowed
In years before 2018, you had the option to carry an NOL forward to future years or back to past years to reduce taxes. Beginning in 2018, you can only carry over an NOL into a future year.
A net operating loss deduction from your taxes can't exceed 80% of taxable income in any year. If your NOL for a year is greater than 80% of taxable income, you will have a carryover to the next year.
Excess Business Losses Limited
In any one year, you can't deduct losses in excess of a threshold amount. Losses over this amount are called excess losses, the amount by which your total business deductions are greater than your total gross business income and business capital gains plus $250,000 (or $500,000 in the case of a joint return). The excess business loss can be carried over to a later tax year.
- A net operating loss occurs when an entity's tax deductions are worth more than its adjusted gross income.
- Individuals, businesses, estates, and trusts can all claim a net operating loss.
- The CARES Act in 2020 expanded the ways entities could claim NOL on previous tax years, but those changes are expected to be temporary.