How to Handle an NOL for an LLC and Carry It Forward

A net operating loss (NOL) occurs when a business’s allowable deductions exceed its taxable income, resulting in a negative taxable amount. For LLCs, this can provide tax benefits by offsetting future profits and reducing overall tax liability. However, handling an NOL correctly requires understanding how it is calculated, carried forward, and reported to the IRS.

LLCs follow different rules for managing NOLs depending on their tax classification and ownership structure. Properly utilizing these losses can minimize taxes over time, but mismanagement may lead to missed opportunities or compliance issues.

Scenarios That May Generate an NOL

An LLC incurs a net operating loss when business expenses exceed revenue in a tax year. This often happens during the startup phase, when costs such as equipment purchases, lease payments, and marketing expenses accumulate before the business generates steady income. Many new businesses operate at a loss in their early years due to these upfront investments.

Economic downturns or industry-specific challenges can also lead to an NOL. A decline in consumer demand, supply chain disruptions, or regulatory changes may reduce revenue while fixed costs like rent, payroll, and insurance remain unchanged. For example, a restaurant experiencing a drop in customers due to local economic conditions may still need to cover operational expenses, resulting in a loss.

Legal settlements and extraordinary expenses can push an LLC into an NOL position. If a business must pay damages in a lawsuit or incurs significant costs from a natural disaster, these expenses may exceed its income. Writing off bad debt from unpaid invoices can also reduce taxable income, increasing the likelihood of an NOL.

Calculating the LLC’s NOL

To determine an LLC’s net operating loss, taxable income is first calculated as if there were no loss limitations. This involves totaling all revenue sources and subtracting allowable business deductions such as rent, salaries, utilities, and depreciation. If the result is negative, the LLC has an NOL, but further adjustments are required.

Certain deductions must be excluded when computing the NOL. The IRS does not allow the standard deduction or personal exemptions in this calculation. Additionally, nonbusiness deductions, such as capital losses exceeding capital gains and certain nonbusiness interest expenses, cannot contribute to the NOL. Only business-related losses and expenses directly tied to the LLC’s operations factor into the final figure.

If the LLC has multiple income sources, such as investment earnings or rental properties, only business-related losses can be included in the NOL calculation. Passive activity losses, which occur when an owner does not materially participate in the business, may be limited under IRS rules. If these losses exceed passive income, they are carried forward separately.

Carryforward Options

Once an LLC determines it has an NOL, the next step is applying it against taxable income in future years. The Internal Revenue Code allows businesses to carry forward NOLs indefinitely under current tax law, meaning the loss can offset future profits until fully utilized. However, the Tax Cuts and Jobs Act (TCJA) of 2017 limits NOL deductions to offsetting up to 80% of taxable income in a given year.

For LLCs taxed as pass-through entities, including partnerships and S corporations, the NOL flows through to members based on their ownership percentage and is reported on their personal tax returns. Individual members must apply the carryforward rules when filing their taxes. If an owner lacks sufficient taxable income to absorb the full NOL deduction in one year, the remaining balance carries forward under the same 80% limitation.

C corporations, including LLCs electing corporate taxation, follow different rules. While they also carry forward losses indefinitely, they do not have the same pass-through treatment as partnerships or S corporations. Instead, the corporation retains the NOL and applies it against future corporate income, reducing corporate tax liability over time.

Single Member and Multi Member Differences

Ownership structure affects how an LLC’s net operating loss is handled, particularly in terms of tax reporting and individual liability. A single-member LLC (SMLLC), by default, is treated as a disregarded entity for tax purposes, meaning its financial activity is reported on the owner’s personal tax return using Schedule C of Form 1040. This setup simplifies the process since the NOL is absorbed entirely by the individual, but the owner must personally meet all deductibility requirements, such as the at-risk and passive activity loss rules under Internal Revenue Code sections 465 and 469.

Multi-member LLCs, typically taxed as partnerships, allocate losses among members based on the operating agreement or, if no specific provisions exist, according to ownership percentages. Each member receives a share of the NOL on their Schedule K-1, which they then report on their individual tax returns. However, their ability to deduct the loss is subject to basis limitations under Internal Revenue Code section 704(d), restricting deductions to the member’s adjusted basis in the LLC. If a member’s share of the NOL exceeds their basis, the excess loss is suspended and carried forward until sufficient basis is restored, often through additional capital contributions or allocated profits.

Reporting Requirements and Recordkeeping

Properly documenting and reporting an NOL ensures compliance with IRS regulations and maximizes tax benefits. Since LLCs can be taxed as sole proprietorships, partnerships, or corporations, the reporting process varies based on the entity’s classification. Maintaining detailed records of income, deductions, and loss calculations is necessary to substantiate the NOL in case of an audit.

For single-member LLCs, the NOL is reported on the owner’s individual tax return using Form 1040, where it is applied against future taxable income. Multi-member LLCs taxed as partnerships distribute the NOL to members via Schedule K-1, requiring each partner to track their share of the loss and apply it appropriately on their personal returns. LLCs electing corporate taxation report NOLs on Form 1120, where they are carried forward and deducted against future corporate earnings. The IRS may require additional disclosures, such as Form 1139 for corporations seeking tentative refunds from prior-year losses.

Maintaining accurate records is essential. Documentation should include financial statements, tax returns, depreciation schedules, and supporting evidence for deductions claimed. Retaining these records for at least three years after the NOL is fully utilized helps protect against IRS challenges. Tracking NOL carryforwards year over year ensures losses are applied correctly and not inadvertently forfeited due to miscalculations or filing errors.