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 minimize taxes for your business in future years. This technique is called a tax loss carryforward because it takes a tax loss in one year and carries it forward one or more years.
This article explains how to qualify for a tax loss carryforward and how the process works for a small business owner.
- Business tax losses (called net operating losses) may be deducted against other income for a tax year.
- The amount of net operating loss you can take may be limited in a tax year for various reasons.
- If you can't deduct all of your loss in one year, you may be able to use tax-loss carryforward rules to deduct this loss from future year's profits.
- You can carry forward 80% of net operating losses for each future year for an unlimited number of years.
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 NOL when expense deductions are greater than income. The word "operating" is key because these losses must come from the business's regular operations.
All types of business owners, except shareholders (owners) of corporations, may claim their share of NOL on their personal tax returns.
Limits on Business Tax Losses
Most small business owners can take the full amount of their business losses to offset other income because they participate in their business and take risks to do so. But a business owner's NOL for a year may be limited depending on the situation.
Some owners don't participate in their business and don't assume any risks. This type of owner might be a limited partner who invests in the partnership but doesn't participate in managing the business. It might also be an owner of rental property, who is considered a passive investor even if they participate in managing the property. This second type of business owner might have their business losses limited to the amount at risk in the business.
In calculating NOL, you must remove other items that limit your loss, including:
- Capital losses in excess of capital gains
- Nonbusiness deductions in excess of nonbusiness income
- The NOL deduction itself
- Qualified business income deductions
What Is a Tax Loss Carryforward?
A tax loss carryforward moves a tax loss freom one year to a future year of profit. Beginning in 2018, the NOL carryover amount is limited to 80% of the excess of taxable income (determined without regard to the deduction). These losses may be carried forward indefinitely.
The CARES Act (2020) temporarily created a special five-year tax carryback allowance and eliminated the 80% limit on net operating losses for 2018, 2019, and 2020. The provisions of this law ended on December 31, 2020.
Who Can Use a Tax Loss Carryforward?
Small business owners and other individuals may use a tax loss carryforward for several different purposes. The most common reason for using this tax provision is to offset income for the year with business losses to reduce taxable income. Sole proprietors, limited liability company members (owners), partners in partnerships, and S corporation owners can use these rules on their share of business income.
Corporations can use loss carryback rules against a net operating loss. 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.
How to Claim a Tax Loss Carry Forward
Here's the general process for determining whether you can take a tax loss carryforward for a tax year.
- 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 NOL. (See Worksheet 1 on IRS Publication 536.)
- If you have more in a net loss than the profit in one year, you will need to calculate the amount of the allowable carryover and apply the 80% limit to see how much you can carry over to future years.
- If you still have a loss after the first year, you can begin again at Step 3 until you have carried forward the entire amount of the loss to future years.
Use IRS Form 1045 Schedule B to calculate the NOL carryover and include it on your personal tax return.
Example of How a Tax Loss Carryforward Works
A business owner has net operating loss of $100,00 in Year 1 and decides to take this loss over four years.
|Available for carryforward||Carryforward amount (80%)||Leftover Amount|
Any additional losses in Years 2, 3, and 4 are added to the original loss, and the 80% limit is applied to the total.
State Laws on Claiming Tax Losses
You may also be able to claim a tax loss against state income taxes. The amount and restrictions vary, and the maximum number of years differs. Check with your state's tax department for details.
Get Help With Loss Carryforward Calculations
There are many rules and exceptions for claiming a tax loss carryforward and the calculations are complicated. Get the help of a licensed tax professional for this process. IRS Publication 536 has more details on how to calculate NOL, how to apply the loss to your tax return, and how to carry it forward to future years.
Frequently Asked Questions (FAQs)
How long can tax losses be carried forward?
Both state and federal tax laws allow tax losses to be carried forward for an indefinite number of years. You can only carry over 80% of the loss from each year. If you have more than one net operating loss (NOL) for the year from several years of losses, apply the NOLs against your modified taxable income, starting with the most recent year.
Which tax form does my loss carryforward go on?
As a small business owner, you pay tax on business income and other income on your personal tax return, Form 1040, or 1040-SR (for seniors).
If you are filing business taxes as a sole proprietor, for example, you report your business income on Schedule C and include this with other income and deductions to get your adjusted gross income for the year. Partners in partnerships and S corporation owners can take a loss carryforward based on their share of business income for the year. They report this income each year by including a Schedule K-1 with their tax return.
If you are reporting a tax loss carryforward for a year, use IRS Form 1045, Schedule B to calculate the loss, then add it to your tax return.
Is there a maximum loss carryforward?
The maximum loss you can carry forward for a year is 80% of taxable income, modified by removing some deductions.
You may have NOL for the year if your adjusted gross income on your tax return is less than your deductions (the standard deduction or itemized deductions). You will need to calculate the NOL by subtracting some of the deductions and losses to figure out the amount you can carry forward to future years. Then you will need to