How Net Operating Loss Works
A net operating loss (NOL) is a situation in which the annual tax deductions of a business or other entity are worth more than the owner’s adjusted gross income (AGI). The owner may be able to use this loss to offset other income on their personal tax return, reducing the owner’s total tax bill. Instead of taking all of the NOL deduction on the year of the loss, a business may carry some of those deductions forward to years when it has a profit, effectively decreasing its tax bill in those years. Most net operating losses are related to business losses. To take the loss, you must include it on your personal tax return, along with other deductions, credits, and income. While different entities can claim an NOL, there are limitations on the types of deductions that can be factored into the equation. To calculate the amount of an NOL, you can use some nonbusiness deductions, including:
AlimonyContributions to an individual retirement account (IRA) or self-employed retirementYour work as an employeeLosses due to casualties or theftRental property
Certain types of losses and deductions aren’t allowed when calculating NOL, including:
Capital losses (from investments or sale of business assets) in excess of capital gains Gains excluded from the sale of small business stock Nonbusiness losses Section 199A (Qualified Business Income) deduction
Example of a Net Operating Loss
Here’s a simplified example of an NOL for a sole proprietor: An individual taxpayer takes the standard deduction of $12,400 and has an AGI of $11,000, including wages from a part-time job, interest income, and a business loss. The person has a preliminary net operating loss of $1,400, but they will have to adjust the amount of the loss for some disallowed deductions.
How to Calculate Net Operating Loss
To calculate your net operating loss, subtract your deductions, either the standard deduction for your filing status or itemized deductions, from your AGI.
Carrying Forward Excess Net Operating Loss
Tax laws limit the amount of net operating loss you can take in any one year. But If you had an NOL in any one year that exceeds the limit, you may be able to take that deduction in future years when you have a profit. This process is called a tax loss carryforward. There are specific rules for calculating the amount of allowable loss.
How to Calculate and Report a Net Operating Loss
To calculate and report NOL, here are some key steps to follow:
Getting Help With NOL
The process of determining, calculating, and carrying over an NOL is complicated. The IRS has limits and restrictions on this process and the amounts you can carry forward and the calculations are daunting. Get the help of a tax professional if you think you have an NOL and you want to use it to reduce taxes.
Losses on the sale of capital assets (like buildings, equipment, and vehicles) that are more than capital gains on those assetsExclusions from gains on qualified small business stocknonbusiness deductions greater than nonbusiness incomeThe section 199A deduction for qualified business incomeThe NOL deduction itself
For example, you could have a loss of $100,000 in one year and carry that loss over to several future profitable years to reduce your taxes in each of those years until the full amount of the loss has been taken.
