What is a Net Operating Loss?
A net operating loss (NOL) results from the situation in which a business or individual has more allowable tax deductions than it has taxable income. In this case, the business has negative income, or a net operating loss. That’s the bad news. But the good news is that you may be able to take that net operating loss and move it to a tax year in which you had a profit (actually, net operating income) either prior years or future years.
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, or
- Rental property.
Most net operating losses are related to business losses. To be considered, these business losses must be included on the owner’s individual tax return. The net operating loss, therefore, is applicable only to pass-through businesses, including sole proprietorships. 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. A net operating loss for corporations is a different type of loss, and not included in this article.
Some business expenses cannot be used to calculate a net operating loss.
For example, losses from home business expenses are limited to those that offset income.
Net operating losses incurred in connection with bankruptcies are not included in this article.
What to Do If You Have a Net Operating Loss
Here’s an overview of the process of finding and taking a net operating loss:
- First, complete your personal tax return (including Schedule C for your business, if applicable) to get to Line 41, your income from exemptions.
- Then you must exclude specific items on your tax return to make sure you can include everything. You will need to calculate the exact amount of the net operating loss for that year.
- Once you’ve determined that you have a net operating loss, you can determine whether to carry the loss back to a previous year (or years) or forward to a future year (or years)
Calculating the Net Operating Loss
The loss from your business is only one part of the net operating loss calculation. For calculation purposes on your personal tax return (Form 1040):
- Calculate Adjusted Gross Income (line 37 of Form 1040)
- Subtract standard or itemized deductions, whichever is applicable.
- The resulting amount, on Line 41, may be a net operating loss.
The next step is to look carefully at the items that go into the loss. Some may not be included. For example, you can’t include;
- Deductions for personal exemptions
- Capital losses in excess of capital gains
- Nonbusiness deductions in excess of nonbusiness income.
- The net operating loss deduction, and
- The domestic production activities deduction.
- There are some other deductions you can’t include. See IRS Publication 536 for more details.
You can see the entire calculation on IRS Form 1045, specifically Schedule A. Note that the title “Tentative Refund” means a “quick refund” by means of a loss carry back.
If it looks like you have a net operating loss, you then have the option of
Moving a Net Operating 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 back (used to offset profits in previous years) a specific number of years, or carried forward (used to offset profits in future years) depending on IRS regulations in effect at the time of the loss.
See this article which explains tax carryback and tax carry forward provisions and how they work.
For more details on Net Operating Loss, limitations and calculations, see IRS Publication 536.
Getting Help with the Net Operating Loss Issue
As you can see from this brief discussion, the process of determining, calculating, and moving the net operating loss is complicated. The IRS has limits and restrictions on this process and the amounts you can carry forward and carry back. If you think you have a net operating loss and you want to use it to reduce taxes, get the help of a qualified tax professional.