What Are the NOL Ordering Rules for Tax Deductions?

A Net Operating Loss (NOL) occurs when a business’s tax-deductible expenses exceed its income for the year. This resulting loss can be used to lower taxable income in a future, profitable year. The use of an NOL requires a precise sequence of calculations, as its interaction with other deductions is governed by specific ordering rules. This article explains the sequence required to correctly calculate and apply an NOL deduction to ensure tax compliance.

Foundational NOL Concepts

The Tax Cuts and Jobs Act of 2017 (TCJA) reshaped the framework for Net Operating Losses. For NOLs arising in tax years after 2017, the rules have been standardized for most taxpayers. A primary change is that these NOLs cannot be carried back to prior tax years. Instead, they are carried forward indefinitely to be used against future profits, a shift from pre-TCJA rules that allowed carrybacks and a 20-year carryforward period.

An NOL is created when certain business deductions exceed gross income in a tax year. To calculate the NOL for a specific year, certain deductions must be disregarded, including the qualified business income deduction and any NOL deduction from other years. The process involves starting with the negative taxable income figure and adding back these specific items to arrive at the true NOL amount.

For noncorporate taxpayers, such as sole proprietors and partners, the “excess business loss” limitation must be applied before an NOL is finalized. Under this rule, business losses are only deductible up to an annual threshold. For 2025, this limit is $313,000 for individual filers and $626,000 for joint filers. Any business loss exceeding this amount is not deductible in the current year and is instead treated as an NOL carryforward.

A rule introduced by the TCJA governs how post-2017 NOLs are used. The deduction for these NOLs in any single future year is limited to 80% of that year’s taxable income. This limitation was reinstated for 2021 and onward after a temporary suspension. This limitation is calculated based on taxable income before the NOL deduction itself is taken, meaning a business with a large NOL carryforward might still have a tax liability in a profitable year.

The Sequence of Deductions Before the NOL

Before an NOL deduction can be applied, other deductions must be calculated first. These preliminary calculations are based on income figures determined without any reduction from an available NOL carryforward. This ensures the NOL does not artificially reduce the income base used to compute other percentage-based deductions.

A primary example is the Qualified Business Income (QBI) deduction, available to owners of many pass-through businesses like sole proprietorships and S corporations. The QBI deduction is generally 20% of qualified business income but is also limited by taxable income. For the purpose of calculating the QBI deduction, taxable income is determined before considering any NOL deduction.

Similarly, the deduction for charitable contributions is subject to limitations based on a percentage of the taxpayer’s adjusted gross income (AGI). For individuals, the common limit for cash contributions is 60% of AGI. When calculating this limit, the AGI figure used is not reduced by any NOL carryforward being brought into that tax year.

This sequence establishes the “taxable income before the NOL deduction.” This resulting figure is the specific number needed to correctly apply the NOL deduction and its associated 80% limitation.

Applying the NOL Deduction

After calculating the “taxable income before the NOL deduction,” the next step is to apply the NOL itself. This is where the 80% taxable income limitation is used. The process is a direct application of the available loss against the calculated income.

The application is a two-part calculation. First, calculate the maximum NOL deduction allowed for the year by multiplying the “taxable income before NOL” figure by 80%. This result represents the ceiling for the NOL deduction in the current year for NOLs generated after 2017.

Second, compare the 80% limit to the total available NOL carryforward from prior years. The actual NOL deduction for the tax year is the lesser of these two amounts. For instance, if the 80% limit is $80,000 and the NOL carryforward is $100,000, the deduction is capped at $80,000. If the limit is $80,000 and the carryforward is only $50,000, the taxpayer can deduct the full $50,000. Any unused portion of the NOL carryforward is carried forward to the next tax year.

Post-NOL Deduction Calculations

After the NOL deduction is subtracted from the pre-NOL taxable income, the final calculations can be made. The ordering rules extend to items computed after the NOL is applied, primarily federal income tax and any available tax credits. The final, post-NOL taxable income figure serves as the basis for these computations.

With the final taxable income established, the regular income tax is calculated using the applicable tax brackets. This resulting tax amount is the tentative tax liability. This figure becomes the starting point for applying tax credits, as many non-refundable credits, which can reduce liability to zero but not create a refund, are limited by the amount of tax owed.

These credits can only be accurately calculated and applied after the final tax liability is known. For example, credits for education or energy often have limitations tied to the tax calculated on the final taxable income. This ensures the benefit of such credits is scaled to the actual tax owed after the NOL deduction.

Comprehensive Calculation Example

To illustrate the ordering rules, consider Jane, a consultant operating as a sole proprietorship. For the tax year, she has $200,000 in gross income, $60,000 in business expenses, and made a $5,000 cash charitable contribution. She also has a $90,000 NOL carryforward from a loss incurred in a prior post-2017 tax year.

Step 1: Determine Taxable Income Before Key Deductions

First, Jane determines her income before calculating deductions. Her net business income is her gross income less business expenses: $200,000 – $60,000 = $140,000. This amount is also her Adjusted Gross Income (AGI) and the starting point for her other deductions.

Step 2: Calculate the QBI and Charitable Contribution Deductions

Jane’s $5,000 charitable contribution is fully deductible as it is below the 60% AGI limit. Her Qualified Business Income (QBI) is $140,000, making her potential QBI deduction $28,000 (20% of $140,000).

Step 3: Calculate Taxable Income Before the NOL Deduction

Next, Jane determines her taxable income before the NOL. Using the 2025 single filer standard deduction of $15,000, the calculation is: $140,000 (AGI) – $15,000 (Standard Deduction) – $5,000 (Charity) – $28,000 (QBI) = $92,000. This $92,000 is her “taxable income before the NOL deduction.”

Step 4: Apply the 80% Limitation and Determine the NOL Deduction

Next, Jane applies the 80% limitation to her pre-NOL taxable income: $92,000 0.80 = $73,600. This is the maximum NOL she can deduct. She compares this $73,600 limit to her available $90,000 NOL carryforward. Her deduction is restricted to the lesser amount, which is $73,600.

Step 5: Calculate Final Taxable Income and Tax Liability

Jane calculates her final taxable income by subtracting the allowable NOL deduction from her pre-NOL taxable income: $92,000 – $73,600 = $18,400. This is the income on which she will calculate her federal income tax. The unused portion of her NOL, $16,400 ($90,000 – $73,600), is carried forward to the next tax year.