Net operating losses: carrying US business losses forward

A business that loses money in a year does not necessarily waste that loss for tax purposes. The net operating loss rules let a loss be carried to another year and used against income there. But the rules changed substantially for losses arising after 2017, and the current regime is quite different from the one many people remember: losses now generally carry forward only, and a carried-forward loss can shelter only part of a later year's income. This guide explains how it works now.

What a net operating loss is

A net operating loss (NOL) arises when a business's allowable deductions exceed its income for the year, producing a loss for tax purposes. The idea behind letting it carry to another year is one of fairness over time: a business whose profits swing between good and bad years should not be taxed as harshly as one with the same total profit spread evenly. It is worth noting that an NOL is a tax figure, computed under specific rules, and is not simply the loss shown in the accounts — some items are adjusted in arriving at it.

Carry forward, generally not back

The single biggest change to internalise concerns direction. Under the rules for losses arising after 2017:

• An NOL is generally carried forward indefinitely — it does not expire, so it waits until the business has income to use it against.
• An NOL generally cannot be carried back to earlier profitable years to claim a refund. Limited exceptions exist, such as certain farming losses.

This reversed the older approach, under which many businesses could carry a loss back and get an immediate refund of tax paid in prior years. That option is largely gone for current losses, so the value of a loss is now realised only in the future, when the business returns to profit.

The 80% limitation

The second key rule limits how much of a carried-forward loss can be used in any one year. For losses arising after 2017, the NOL deduction in a carryforward year is generally capped at 80% of that year's taxable income (figured before the NOL deduction). The consequence is that a large loss carried forward cannot eliminate 100% of a later year's income — at least 20% of that income generally remains taxable — and any unused portion of the loss simply carries on to the next year. So a business emerging from losses into a strong year will usually still pay some tax, rather than offsetting the whole profit at once.

Corporations versus pass-throughs

Where the loss sits depends on the entity. A C corporation computes and carries its own NOL at the entity level, applying it on Form 1120 in later years. For a pass-through — a partnership or S corporation — the loss instead flows out to the owners, where it runs a gauntlet of owner-level limits (basis, at-risk, and passive-activity rules) and then the excess business loss limitation for non-corporate taxpayers, which caps how much business loss an individual can use against other income in a year and turns the excess into an NOL carried forward. That excess-business-loss limitation has been made a permanent part of the rules. Losses are often the product of large deductions such as accelerated depreciation stacked on ordinary business expenses, so understanding how the resulting NOL behaves is part of planning those deductions. And when a business is wound up, unused losses raise their own questions, touched on in final returns after closing.

Sources

This guide is written against the official and clearly labelled professional references below. Rates, thresholds and portal procedures change between reviews, so open the primary source before relying on a figure.

• About Publication 536, Net Operating Losses (IRS)
• Businesses (Internal Revenue Service)

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