A tax loss isn't necessarily all bad news. If you have a tax loss in one year, you might be able to use that loss to offset profits in future years, to minimize taxes for your business in those years. This technique is called a tax loss carry forward because it takes a tax loss in one year and carries it into a future year.
Changes to Net Operating Loss Taxes
For tax years beginning in 2018, under the Tax Cuts and Jobs Act, the IRS has changed the net operating loss rules.
You can no longer take a net operating loss carryback, except for certain farming losses.
The net operating loss deduction can't be over 80% of taxable income.
Losses for small businesses that are not corporations are limited. You can't deduct overall net business losses that are more than a threshold amount in the current year. If you have net operating losses more than this threshold, you can carry them forward to the next year.
The CARES Act (2020) made some additional changes to provide tax relief for taxpayers with net operating losses, including temporarily allowing NOL carrybacks and removing the 80% limit for tax years before 2021. These provisions are complicated; check with your tax advisor.
What is a Tax Loss?
A tax loss, otherwise known as a Net Operating Loss (NOL), is the opposite of a profit (net income). A business has a loss when expense deductions are greater than income. The word "operating" is key, because these losses must come from the business's regular operations.
Net operating losses are allowed for individuals, not businesses. The loss must be included on the business owner's personal tax return. For this reason, businesses can take an NOL if they are some types of pass-through businesses - sole proprietors or single-member LLCs, but not general partnerships, S corporations, or corporations. Individual partners or S corporation owners may claim their share of the loss on their personal tax return.
What is a Tax Loss Carry Forward?
A Tax Loss Carry Forward carries a tax loss from a business over to a future year of profit. For losses arising in taxable years beginning after Dec. 31, 2017, the net operating loss carryover is limited to 80% of taxable income (determined without regard to the deduction).
In years before 2018, tax loss carryforwards could only be used for 20 years, but under the new tax law, tax losses may be carried forward indefinitely.
You may also be able to claim a tax loss against state income taxes. The amount and restrictions vary by state. Check with your state's tax department for details.
Who Can Use a Tax Loss Carry Forward?
Corporations can use these provisions against a net operating loss in the same way as individual taxpayers. The corporation can take different deductions and it must make some changes to its taxable income to figure the NOL. It also uses different forms to report net operating losses on its tax return.
Individual taxpayers may also use a tax loss carryforward for several different purposes. For example, if you have made excess contributions to a state's 529 plan (saving for education costs) you can't deduct the excess amount, but you may be able to carry the amount over to future years, subject to the 80% limit.
How to Claim a Tax Loss Carry Forward
Here's the general process for determining whether you want to take a tax loss carry forward.
- First, complete the tax return for your business type and make sure your business type allows the tax loss carryover provision.
- Then determine if you have a net operating loss. There is a (complicated) calculation used to determine an NOL.
- If you have more in a net loss than the profit in one year, you may be able to carry over the unused NOL to the next carryforward year. Then you will need to apply the 80 percent limit.
- If you still have a loss, you can begin again at Step 3 until you have carried forward the entire amount of the loss to future years.
Be sure to keep excellent records of all tax claims. You should keep records for any tax year that generates an NOL for three years after the carryforward expires.
Get Help with NOL Calculations
There are many rules and exceptions for claiming a tax loss carryforward. That's another reason for making sure you get the help of a tax professional for this process. IRS Publication 536 - Net Operating Losses (NOL's) for Individuals, Estates, and Trusts has more details on how to calculate a Net Operating Loss, how to apply the loss to your tax return, and how to carry it forward to future years.
The information contained in this article is not tax or legal advice. Laws and tax regulations change, and there are many complicated restrictions and qualifications.