What Are the C Corp Loss Carry Forward Rules?

A C corporation experiences a net operating loss (NOL) when its allowable tax deductions are greater than its gross income in a given year. The tax code allows corporations to use these losses to offset income in profitable years through a process known as a loss carryforward.

The purpose of an NOL carryforward is to smooth a corporation’s tax liability over time. By carrying a loss forward, a corporation can reduce its taxable income in a future year. This leads to a more equitable tax outcome that reflects its overall profitability across multiple periods and aligns tax payments with long-term economic performance.

Determining Your Net Operating Loss

A net operating loss calculation begins with the annual corporate income tax return, Form 1120, “U.S. Corporation Income Tax Return.” The initial loss figure is the negative number on the taxable income line before any NOL deductions from other years are applied.

To determine the precise NOL amount for the current year, you must make adjustments to this initial figure. A key modification is to add back any NOL deduction claimed in the current year that originated from a loss in a prior year. This adjustment isolates the loss generated exclusively in the current tax period, resulting in the specific NOL amount available to be carried forward.

For example, if a corporation has a taxable loss of $150,000 after claiming a $50,000 NOL deduction from a previous year, its NOL for the current year is $100,000. This is the amount that can be carried forward to offset future income.

Rules for Carrying Forward the Loss

The regulations for using a net operating loss are dictated by the tax year in which the loss occurred. The Tax Cuts and Jobs Act of 2017 (TCJA) significantly altered the treatment of NOLs for C corporations, creating different sets of rules based on the loss year.

For losses that arise in tax years beginning after December 31, 2017, two main rules apply. First, these NOLs can be carried forward indefinitely until the full amount is used. Second, the NOL deduction in any single future year is limited to 80% of the corporation’s taxable income for that year, calculated before the NOL deduction is taken.

To illustrate, consider a corporation with $500,000 in taxable income and a $600,000 NOL carryforward from a post-2017 year. The maximum NOL deduction it can take is 80% of $500,000, which is $400,000. This reduces its taxable income to $100,000, and the remaining $200,000 of the NOL is carried forward to subsequent years.

For losses that originated in tax years beginning before January 1, 2018, the prior rules still apply. These pre-2018 NOLs can be carried forward for up to 20 years and are not subject to the 80% taxable income limitation. A corporation with both pre-2018 and post-2017 NOLs must use the pre-2018 losses first, which can offset 100% of taxable income.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 introduced temporary changes, including a five-year carryback for losses from 2018-2020 and a suspension of the 80% limit. However, for losses in tax years after 2020, the carryback option is no longer available for most corporations, and the 80% limitation is in effect.

Claiming the NOL Deduction on Your Tax Return

A corporation claims an available net operating loss carryforward on its annual tax return, Form 1120. The NOL deduction is reported on a designated line that appears after most other business deductions are calculated but before the final taxable income is determined.

To support the amount claimed, a corporation must attach a detailed statement to its tax return. This statement should show the total NOL carryforwards available, identify the year each loss originated, and detail how the current year’s deduction was calculated, applying any relevant limitations.

Proper internal record-keeping is required for managing NOL carryforwards. A corporation must maintain a schedule tracking the original amount of the NOL for each loss year, the amount used in each subsequent year, and the remaining balance. These records are for ensuring tax return accuracy and for substantiating the deduction if the IRS examines the return.

Special Limitations on NOL Carryforwards

Beyond the 80% income limitation, other rules can restrict the use of NOL carryforwards. The most significant is found in the Internal Revenue Code, which applies when a corporation undergoes a substantial “ownership change.” This provision is designed to prevent corporations from being acquired solely to use their losses to shelter an acquirer’s future income.

An ownership change is defined as a shift of more than 50 percentage points in the corporation’s stock ownership over a three-year period, measured by the holdings of shareholders who own 5% or more of the stock. If such a change occurs, the corporation’s ability to use its pre-change NOLs becomes subject to an annual limitation.

This annual limit is calculated by multiplying the fair market value of the corporation’s stock immediately before the ownership change by the long-term tax-exempt rate, a rate published monthly by the IRS. For example, if a corporation valued at $2 million undergoes an ownership change when the applicable rate is 3%, its annual NOL usage from pre-change years would be limited to $60,000.

This limitation is applied in addition to the 80% taxable income rule. The corporation must comply with whichever limitation is more restrictive in a given year.