How to Make an NOL Carryback Election

A net operating loss, or NOL, occurs when a business’s allowable tax deductions are greater than its taxable income for the year. One way to use an NOL is through a carryback election. This allows a taxpayer to apply the current year’s loss against taxable income from a previous, profitable year, which generates a refund of taxes paid in that prior year. This mechanism can help smooth out income and tax liability over time, particularly for businesses in cyclical industries. The choice to use a carryback is available only under specific circumstances defined by current tax law.

Determining Eligibility for an NOL Carryback

For most taxpayers, the ability to carry a net operating loss back to a prior tax year has been eliminated. Generally, NOLs arising in tax years after 2020 can only be carried forward to future years. However, the tax code provides specific exceptions to this rule, allowing certain taxpayers to make a carryback election. These exceptions provide a pathway for immediate tax relief for qualifying businesses.

The primary exceptions apply to losses from specific types of businesses. One exception is for taxpayers with eligible farming losses, which can be carried back two years and then carried forward indefinitely until the loss is fully used. For a loss to qualify as a farming loss, it must originate from a farming business, which the IRS defines as a trade or business involved in the cultivation of land or the raising of any agricultural commodity. This can include individuals, trusts, estates, and C corporations engaged in farming operations.

Another exception is provided for certain insurance companies. Losses incurred by insurance companies, other than life insurance companies, are also eligible for a two-year carryback. These losses have a more limited carryforward period of 20 years. Taxpayers who do not fall into one of these explicit categories are unable to carry back a net operating loss and must instead carry it forward to offset future income.

Required Calculations and Documentation

Two distinct calculations are necessary to determine the amount of the potential carryback. The first step is to accurately calculate the net operating loss for the current tax year, which requires specific adjustments and is not simply the negative number on a tax return. For example, an NOL is calculated without including any NOL carryovers or carrybacks from other years. For individual taxpayers, certain nonbusiness deductions that exceed nonbusiness income must be removed, as must any capital losses greater than capital gains. The IRS provides detailed worksheets, such as in Publication 536, to guide taxpayers.

Once the official NOL amount is determined, the second calculation is to figure the refund amount from the carryback year. This involves applying the NOL to the income of the earliest eligible prior year. The taxpayer must recompute the tax liability for that prior year by deducting the NOL from the original income. If the NOL is larger than the modified taxable income of that earliest year, the remaining loss is carried to the next year. This recalculation determines the overpayment of tax, which is the amount of the refund.

To support the carryback claim, specific documentation must be gathered and maintained. This includes a complete copy of the income tax return for the year the NOL occurred, showing how the loss was calculated. It also requires a copy of the original tax return for the carryback year being amended. Also necessary are detailed computations showing the NOL calculation and the re-computation of the prior year’s tax liability, which must be attached to the official forms.

How to File for a Carryback Refund

A taxpayer can formally request a refund using one of two methods. The first is to apply for a tentative, or “quick,” refund by filing either Form 1045, Application for Tentative Refund, for individuals, estates, and trusts, or Form 1139, Corporation Application for Tentative Refund, for C corporations. These forms are favored because the IRS is required to review the application and issue a refund within a 90-day period, providing faster access to cash flow.

The deadline for filing Form 1045 or Form 1139 is strict. The application must be filed within 12 months after the end of the tax year in which the NOL arose. For example, for an NOL that occurred in a calendar year ending December 31, 2024, the form must be filed by December 31, 2025.

The second method for claiming a carryback refund is to file an amended tax return for the carryback year. Individuals use Form 1040-X, Amended U.S. Individual Income Tax Return, while corporations file Form 1120-X, Amended U.S. Corporation Income Tax Return. This approach has a more generous filing deadline, generally allowing three years from the due date of the return for the NOL year. The trade-off is a significantly longer processing time, as amended returns are not subject to the 90-day processing target.

Electing to Waive the Carryback Period

For taxpayers who are eligible to carry back a net operating loss, the carryback is automatic. If a taxpayer decides that carrying the loss forward is more advantageous, they must make a formal election to waive the carryback period. This choice allows the taxpayer to forgo the immediate refund in favor of reducing taxable income in subsequent profitable years. The decision to waive the carryback is a strategic one that depends on financial projections.

To make this election, the taxpayer must attach a statement to their original, timely-filed income tax return for the year the NOL occurred. This statement must declare that the taxpayer is electing to waive the carryback period under Internal Revenue Code Section 172. The election must be made by the due date of the return for the NOL year, including any extensions.

This election is irrevocable. Once the decision to waive the carryback period is made and the tax return is filed, it cannot be changed. A taxpayer cannot later file an amended return to claim the carryback if they initially chose to waive it. This finality requires careful consideration of the benefits of a carryforward versus an immediate refund.