What Is a Net Operating Loss (NOL)?

Many businesses don’t make any money, particularly during their first year of operation. When this happens, the IRS provides business owners with some tax relief in the form of something called a net operating loss (NOL). What follows is a summary of the basics that you need to know about this tax break. If you need help making sense of any financial concepts for your business, consider finding a financial advisor who specializes in business planning.

Net Operating Losses: The Basics

A net operating loss (NOL) occurs when a company has more tax deductions than taxable income in a given year. When business owners have a NOL, they don’t owe any taxes for that particular year. What’s more, they might be able to get a refund for taxes paid in previous years or use their business losses to lower their taxable income in the future.

While companies themselves can’t get a tax break if they’re pass-through entities (like sole proprietorships, partnerships and S corporations) their owners can apply their net operating losses on their personal income tax returns. C corporations are taxed at the corporate level, so their losses are applied on their corporate income tax returns.

Net Operating Loss Carryback

The Tax Cuts and Jobs Act (TCJA) of 2017 significantly altered the rules surrounding net operating loss (NOL) carrybacks. Before the TCJA, businesses could carry back NOLs to offset taxable income from the two prior tax years, which allowed them to claim refunds for taxes already paid during profitable years. This was a valuable mechanism for improving cash flow, particularly for businesses facing volatile earnings.

After the TCJA took effect on Jan. 1, 2018, the ability to carry back NOLs was eliminated for most businesses. This means NOLs incurred in 2018 and subsequent years can no longer be used to amend previous tax returns and claim refunds.

The elimination of carrybacks was intended to simplify the tax system and align with the broader corporate tax reforms introduced by the TCJA, such as the reduction of the corporate tax rate to a flat 21%.

There are exceptions to this rule: certain businesses, including farming enterprises and specific insurance companies, are still allowed to carry back NOLs up to two years. These exceptions recognize the unique challenges these industries face, such as irregular income cycles and catastrophic losses.

Net Operating Loss Carryforward

The TCJA also introduced indefinite carryforwards, allowing NOLs generated after 2017 to be used in future years without expiration. However, these carryforwards are subject to an 80% taxable income limitation, meaning NOL deductions in any given year cannot reduce taxable income by more than 80%. This cap ensures that businesses cannot eliminate their entire tax liability in profitable years, which contrasts with the pre-TCJA rules that allowed full offsets against taxable income.

To claim an NOL, businesses and individuals must file IRS Form 1045 (Application for Tentative Refund) or amend prior tax returns using Form 1040-X (for individuals) or Form 1120-X (for corporations). For carryforwards, NOLs are applied automatically to future years’ taxable income when the entity files its annual return.

Bottom Line

When you’re running a business, losing money isn’t the end of the world. Being able to use a loss carryforward or a loss carryback technique can relieve some of your tax burden. If you have a NOL, you’ll need to think carefully before deciding what to do with it. By adhering to IRS rules and maintaining accurate records, taxpayers can leverage NOLs to offset taxable income and reduce tax burdens over time.

Money Management Tips

• A financial advisor can help with all sorts of money issues, including managing profit lines for a business. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• You’ll want to know what your tax burden might look like before you make any other decisions about how to manage your funds for the year. Use SmartAsset’s free income tax calculator to see how much you might owe Uncle Sam, and keep that figure in mind as you budget for the year.

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