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). If you’re not sure what a NOL is or you don’t know how to make the most of it, read on. We’ll tell you everything you need to know about it.
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
Carrying a NOL back or forward will apply losses to income tax returns from past and/or future years. The benefit of this is that a NOL can reduce your tax liability.
The year the net operating loss happens is known as the NOL year. If you have a NOL, you may be able to carry that amount back to two years before the NOL year. This two-year time frame is known as the carryback period. If your net operating loss occurs following a theft or another incident, you may qualify for a three-year carryback period.
Taxpayers who want to carry back net operating losses can apply them to a past tax return by filing an amended return (using IRS Form 1040x). If there’s anything left over, you’ll have to carry it forward and apply it to a future tax return.
If you want to receive your refund more quickly, you can file Form 1045 instead of Form 1040x. This form – known as the Application for Tentative Refund – will ensure that you receive your tax refund within 90 days. But according to IRS rules, you’re required to file this form within a year following the NOL.
Net Operating Loss Carryforward
If you don’t want to carry your NOL back, you can carry it forward at any point within a 20-year period. That’s worth considering, particularly if you haven’t paid taxes for the past two years. After 20 years have passed, any NOL that’s left over gets canceled.
If you want to forgo the carryback period and carry the amount of your NOL forward, you’ll need to include a statement with your tax return for the NOL year saying that you’re doing so. If you file your tax return without attaching a statement, you can always file an amended tax return within six months of your tax due date (that time frame doesn’t account for filing extensions). It’s best to write “filed pursuant to section 301.9100-2” at the top of the statement you file with your amended tax return.
When calculating your NOL, there are certain deductions that you’ll need to leave out. For example, business owners who don’t pay corporate income taxes must exclude personal exemptions and any net capital losses (when capital losses exceed capital gains).
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. After all, once you waive your carryback period, your decision generally can’t be reversed. If you end up with NOLs in multiple years, you’ll need to use the oldest one first.
Photo credit: ©iStock.com/AndreyPopov, ©iStock.com/jasasstyle, ©iStock.com/Olivier Le Moal