Do Net Operating Losses (NOLs) Expire?
Discover how the lifespan of a net operating loss is determined by when it was generated, reflecting key shifts in federal and state tax regulations.
A net operating loss (NOL) occurs when a company’s or individual’s allowable tax deductions are greater than their taxable income for a given year. This loss can be used to offset taxable income in other years, potentially reducing tax liability. Whether an NOL expires depends on the specific year in which the loss was generated, as federal tax laws have established different treatments for losses arising before and after key legislative changes.
Expiration Rules for NOLs Before 2018
For net operating losses that originated in tax years starting before January 1, 2018, the rules were defined by a specific lifespan. These NOLs were subject to a 20-year carryforward period. This meant that if a business or individual could not use the entire value of the loss to offset profits within two decades, any remaining amount would expire and could no longer be used for tax purposes. This 20-year limit created a finite window for taxpayers to realize the full benefit of the loss.
In addition to the carryforward provision, these older NOLs allowed for a two-year carryback. This provision permitted taxpayers to apply the loss against taxable income from the two preceding years, which could result in an immediate tax refund. A taxpayer could file an amended return for a prior profitable year, apply the NOL, and receive back taxes paid for that year. Taxpayers also had the option to make an irrevocable election to waive this carryback and only carry the loss forward.
Expiration Rules for NOLs After 2017
A shift in tax law altered the treatment of net operating losses arising in tax years beginning after December 31, 2017. The Tax Cuts and Jobs Act (TCJA) eliminated the expiration date for these NOLs. Losses generated in 2018 or later can now be carried forward indefinitely until the full amount is used.
This indefinite carryforward period came with a trade-off: the deduction for these NOLs is now subject to a limitation. The NOL deduction is restricted to 80% of the taxable income for the year it is used. For example, if a company has $1 million in taxable income and a large NOL from a prior year, it can only use the NOL to offset $800,000 of that income, leaving $200,000 in taxable income. This rule was temporarily suspended for the 2019 and 2020 tax years, but the 80% limitation is now back in effect.
The TCJA also eliminated the two-year carryback provision for most taxpayers. However, certain exceptions remain, such as for farming businesses, which can still carry back losses for two years. Special rules also apply to non-life insurance companies, which are permitted a two-year carryback and a 20-year carryforward. A temporary exception created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which allowed NOLs from 2018, 2019, and 2020 to be carried back for up to five years, has since ended.
State-Level NOL Considerations
The federal rules for net operating losses do not automatically apply at the state level. Each state with an income tax has its own regulations for how NOLs are treated, and these can differ from the guidelines set by the IRS. This divergence is often referred to as “decoupling,” where a state chooses not to adopt certain provisions of the federal tax code.
The variation among states is wide. Some states automatically conform to the federal Internal Revenue Code as it changes, a practice known as “rolling conformity.” These states may have adopted the indefinite carryforward and 80% limitation. Other states use “static” or “fixed-date” conformity, meaning they adhere to the federal code as it existed on a specific date, potentially before the 2017 changes. This can result in a state retaining a 20-year carryforward limit for NOLs.
Furthermore, some states have established their own unique NOL rules entirely independent of federal law. For instance, a state might have a 10- or 15-year carryforward period, while another might conform to the indefinite carryforward but decouple from the 80% income limitation. Because of this complex landscape, any individual or business with an NOL should consult their specific state’s tax authority or a tax professional to understand the applicable rules.