IRS Net Operating Loss Rules and Procedures

A net operating loss (NOL) occurs when a taxpayer’s allowable tax deductions for a year are greater than their taxable income. The tax code allows taxpayers to use a loss from one year to reduce their tax liability in a different year, offering a form of tax relief.

This relief is primarily available to businesses, including those operated by sole proprietors, partners in a partnership, and certain individuals with specific types of losses. C-corporations, estates, and trusts can also generate and use NOLs. The ability to apply losses from a lean year against income from a profitable year helps to smooth out tax liabilities over time.

Identifying and Calculating a Net Operating Loss

A taxpayer may have a net operating loss if their deductions exceed their income for the year. This is common for individuals with business losses reported on Schedule C, Schedule E, or Schedule F. A loss from operating a business is the most frequent reason for an NOL, and it is not simply the negative taxable income figure at the bottom of a tax return.

Before calculating a potential NOL, noncorporate taxpayers—such as individuals, estates, and trusts—must first apply the excess business loss limitation. For 2025, total business losses are limited to $313,000 for single filers and $626,000 for joint filers. If a taxpayer’s net business losses exceed this threshold, the excess amount is not deductible in the current year. This “excess business loss” is treated as a net operating loss carryforward to the following year.

To determine the actual NOL amount, a taxpayer must make several specific adjustments to their negative taxable income because certain deductions are not permitted when calculating an NOL. The IRS provides detailed worksheets, such as those in Publication 536 or on Schedule A of Form 1045, to guide taxpayers through this calculation.

One of the primary modifications is that an NOL deduction from other years cannot be used to create or increase a current year’s NOL. Additionally, for individual taxpayers, the Qualified Business Income (QBI) deduction is not allowed in the NOL calculation.

Further adjustments relate to nonbusiness income and deductions. Nonbusiness capital losses can only be deducted up to the amount of nonbusiness capital gains. Similarly, nonbusiness deductions are only allowed to the extent of nonbusiness income. Nonbusiness income includes items like dividends and interest, while nonbusiness deductions include standard or itemized deductions not related to a trade or business.

NOL Carryback and Carryforward Rules

The rules for using a Net Operating Loss have undergone significant changes due to the Tax Cuts and Jobs Act (TCJA) and the CARES Act. Under current rules, NOLs that arise in tax years beginning after 2020 can only be carried forward. These carryforwards can be used indefinitely until the loss is fully absorbed.

A temporary exception introduced by the CARES Act allowed NOLs from the 2018, 2019, and 2020 tax years to be carried back five years for immediate tax refunds. While the deadline for this special carryback has passed, it is important context for recent NOL history. A notable exception to the no-carryback rule that persists is for certain farming losses, which can be carried back two years.

A limitation applies to the use of NOL carryforwards, creating a two-tiered system based on when the loss occurred. NOLs carried forward from tax years before 2018 can be used to offset 100% of taxable income. After these older NOLs are used, losses from tax years 2018 or later are subject to a limit. The deduction for these newer losses is capped at 80% of the year’s remaining taxable income, and the unused portion can be carried forward.

For years when a carryback was permissible, taxpayers could file an irrevocable election to waive the carryback period and only carry the loss forward. This choice might be advantageous if future income is expected to be taxed at a higher rate than the income in the carryback years, making the deduction more valuable.

Procedures for Claiming an NOL Refund or Deduction

Specific procedures must be followed to claim an NOL. The method depends on whether the loss is being applied to a prior year for a refund or to a future year as a deduction.

When a carryback is permitted, the faster method for claiming a refund is to file Form 1045, Application for Tentative Refund. This form must be filed within 12 months after the end of the tax year in which the NOL occurred. The IRS is required to process these applications within 90 days.

The second method for a carryback is to file Form 1040-X, Amended U.S. Individual Income Tax Return. This option provides a longer filing deadline of three years, but the processing time for the refund is slower, often taking six months or more. When filing Form 1040-X for an NOL carryback, a copy of the NOL calculation from Schedule A of Form 1045 must be attached.

For carryforwards, the procedure is to claim the NOL as a deduction on a future tax return. The NOL deduction is reported as a negative number on the “Other Income” line of Schedule 1 (Form 1040). A statement must be attached to the tax return that details how the NOL deduction was calculated, showing the original NOL amount, amounts used in prior years, and the remaining balance.

Special Considerations for Different Entity Types

The rules for net operating losses apply differently depending on the structure of the business entity.

Pass-Through Entities

S-corporations and partnerships are pass-through entities, meaning they do not pay income tax at the entity level. Consequently, these entities do not have or use NOLs themselves. Instead, any business income or loss is passed through to the individual owners or partners on their Schedule K-1. The owners then combine these figures with their other personal income and deductions on their Form 1040, where an NOL may be created.

C-Corporations

C-corporations are taxed as separate legal entities and therefore calculate and use NOLs at the corporate level. The principles are similar to those for individuals, but corporations use a different set of tax forms. The primary form for a corporation’s income tax return is Form 1120. To claim an NOL carryback refund, a corporation files Form 1139 for a quick refund or Form 1120-X for an amended return.

Estates and Trusts

Estates and trusts can also generate net operating losses from their activities. The rules for calculating and using these NOLs are similar to the rules that apply to individual taxpayers. These entities report their income and deductions on Form 1041, U.S. Income Tax Return for Estates and Trusts, and use this form series to manage NOLs.