Can Taxable Income Be Negative? How It Happens and What It Means

Taxable income is the amount of income subject to taxation after deductions and adjustments. While most expect this number to be positive, it can sometimes fall below zero, meaning a taxpayer has no taxable income and may carry losses forward to future years.

Understanding how taxable income becomes negative is important because it affects tax liability and future filings.

Situations Where Taxable Income Can Fall Below Zero

Taxable income turns negative when deductions, business losses, or tax adjustments exceed total income. This applies to individuals, self-employed professionals, and corporations, influencing both current tax obligations and future filings.

Business Losses

A common reason for negative taxable income is when business expenses surpass revenue. Self-employed individuals, sole proprietors, and corporations can deduct ordinary and necessary expenses under the Internal Revenue Code. If these deductions exceed gross income, the result is a business loss.

For example, a sole proprietor running a retail store earns $50,000 in revenue but incurs $70,000 in expenses, including rent, payroll, inventory, and marketing. This results in a $20,000 loss, eliminating taxable income and allowing the loss to be carried forward or backward under certain provisions.

Corporations reporting losses under Generally Accepted Accounting Principles (GAAP) may also show negative taxable income. This can impact future tax obligations by offsetting profits in later years.

Large Deductions

Significant deductions unrelated to business operations can also push taxable income below zero. These include student loan interest, medical expenses, and contributions to tax-advantaged retirement accounts. The standard or itemized deductions play a major role in this process.

In 2024, the standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly. If a taxpayer’s total income is already low, applying these deductions can reduce taxable income to a negative figure.

Itemized deductions can have an even greater impact. Medical expenses exceeding 7.5% of adjusted gross income (AGI) and substantial mortgage interest or state and local tax (SALT) deductions can drive taxable income below zero. For example, an individual with an AGI of $40,000 who incurs $15,000 in qualifying medical expenses can deduct a portion, potentially resulting in negative taxable income.

Special Adjustments

Certain tax adjustments, such as capital losses and depreciation, can also lead to negative taxable income. When an investor sells assets like stocks or real estate at a loss, they can offset capital gains and deduct up to $3,000 annually against ordinary income. Any remaining losses carry forward to future years.

Depreciation deductions have a similar effect, particularly for real estate investors and business owners. Under the Modified Accelerated Cost Recovery System (MACRS), businesses can deduct the cost of assets over time. Bonus depreciation and Section 179 deductions allow for larger upfront deductions, which can create negative taxable income in the year the asset is purchased.

For example, if a business buys $100,000 worth of equipment and deducts the full amount under Section 179, it could significantly reduce or eliminate taxable income, even if the business was profitable before applying the deduction.

Effects on Tax Liability

When taxable income drops below zero, there is no immediate tax burden. This benefits individuals and businesses that would otherwise owe taxes, as they may avoid payments or qualify for refunds if they had taxes withheld or made estimated payments.

Refundable tax credits can also increase the amount returned to taxpayers. The Earned Income Tax Credit (EITC), for example, is available to low-to-moderate-income workers even if no tax is owed. Similarly, the Additional Child Tax Credit allows eligible taxpayers to receive a refund beyond their tax liability.

Beyond immediate tax savings, negative taxable income can impact future filings. Excess deductions or losses can be carried forward, reducing future tax obligations. This is particularly useful for individuals with fluctuating income or businesses experiencing temporary downturns.

Net Operating Loss Calculation

When taxable income falls below zero due to eligible deductions and expenses, the resulting negative figure is classified as a Net Operating Loss (NOL). The IRS allows taxpayers to use this loss to offset taxable income in future years. However, not all deductions contributing to negative taxable income are included in the final NOL calculation.

To determine an NOL, taxpayers start with their negative taxable income and adjust based on IRS guidelines. Certain deductions, such as the standard deduction or personal exemptions, are excluded. Additionally, nonbusiness-related capital losses exceeding capital gains and nonbusiness deductions that exceed nonbusiness income must be removed.

For example, if an individual reports a $30,000 negative taxable income but $5,000 of that stems from excess nonbusiness capital losses, the actual NOL is reduced to $25,000.

Once the NOL is calculated, it can be carried forward to offset income in future tax years. Under current tax law, NOLs can no longer be carried back but can be carried forward indefinitely, subject to an 80% taxable income limitation under the Internal Revenue Code. This means that if a taxpayer has $100,000 in taxable income in a future year and a $50,000 NOL carryforward, only $40,000 (80% of $50,000) can be used to offset income in that year, with the remaining balance carried forward.