Net Operating Loss (NOL): IRS Rules and How to Claim

A net operating loss (NOL) is a tax provision that allows taxpayers to use a financial loss from one year to lower their taxable income in another, enabling them to average their income and losses over multiple years. When allowable tax deductions for a year exceed the total income earned, the resulting negative taxable income can create an NOL. This loss can then be applied in other tax years to reduce future tax liabilities or, in limited cases, obtain a refund for taxes previously paid.

Defining a Net Operating Loss

An NOL occurs when a taxpayer’s deductions for a year are greater than their gross income. This concept helps mitigate the issues that can arise from a strict annual accounting period for those with fluctuating income. The primary taxpayers who can have an NOL include individuals, C corporations, estates, and trusts.

The treatment of NOLs for pass-through entities, like partnerships and S corporations, is distinct. These entities do not claim an NOL at the business level. Instead, the business’s income and losses are passed through to the individual partners or shareholders, who report their share on their personal tax returns.

If combining the business loss with their other income and deductions results in an overall loss on the individual’s return, they may have a personal NOL. Therefore, the loss from a pass-through business is a component that contributes to the owner’s potential NOL, rather than being an NOL of the business entity itself.

Calculating Your Individual or Corporate NOL

Calculating an NOL involves adjusting the loss figure from a tax return and is not simply the negative number on a Form 1040 or Form 1120. The IRS requires specific modifications to isolate the economic loss from business operations.

For individuals, the calculation starts with the adjusted gross income (AGI) on Form 1040. You must add back any NOL deduction carried from other years, as a prior year’s NOL cannot create a new one. You must also add back certain nonbusiness deductions that exceed your nonbusiness income. Nonbusiness income includes items like interest and dividends, while nonbusiness deductions include the standard deduction or itemized deductions like medical expenses.

Noncorporate taxpayers must also apply the excess business loss (EBL) limitation under Internal Revenue Code Section 461. This rule limits the total net business losses a taxpayer can deduct in one year. For 2024, the threshold is $305,000 for single filers and $610,000 for married couples filing jointly. Any business loss beyond this limit is treated as an NOL carryforward to the next tax year.

For C corporations, the calculation uses Form 1120 as the starting point and requires modifications to the taxable loss. A corporation must add back any NOL deduction from other years. Unlike individuals, corporations generally do not have to distinguish between business and nonbusiness income and deductions, which simplifies the calculation.

NOL Carryforward and Carryback Rules

Once an NOL is calculated, specific rules govern how it applies to other tax years. For most NOLs arising in tax years after 2020, the loss can be carried forward indefinitely until the full amount is used. The option to carry the loss back to prior tax years has been eliminated for most taxpayers.

A rule for these post-2020 NOLs is the 80% taxable income limitation. The NOL deduction in any single carryforward year is limited to 80% of your taxable income for that year, calculated before applying the NOL deduction. For example, with $100,000 in taxable income, you could only use an NOL to offset $80,000 of that income. The remaining NOL carries forward to future years, subject to the same 80% limit.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily allowed NOLs from 2018, 2019, and 2020 to be carried back five years, but this provision is no longer in effect for new NOLs. Current exceptions to the no-carryback rule exist for certain farming losses and for non-life insurance companies, which have their own specific carryback periods.

How to Claim an NOL with the IRS

The method for claiming an NOL depends on whether you are carrying it forward or, when permitted, carrying it back. For most taxpayers, the only option is a carryforward. To do this, you report the NOL as a deduction on the tax return for the year you are carrying it to. Individuals report this on Schedule 1 (Form 1040) under “Other Income.”

In the limited situations where a carryback is allowed, such as for certain farming losses, there are two methods to claim a refund. The faster method is to file an application for a tentative refund using either Form 1045 for individuals or Form 1139 for corporations. These forms must be filed within 12 months after the end of the tax year in which the NOL occurred. The IRS processes these applications quickly, often within 90 days, but the refund is considered tentative and subject to later examination.

The other method for claiming a carryback is to file an amended tax return for the prior year. Individuals use Form 1040-X to report the NOL deduction and recalculate the tax. The deadline for filing an amended return is typically three years from the due date of the return for the year that created the NOL.