Net Operating Loss (NOL): Tax Benefits and Calculation Guide


A net operating loss happens when the allowable tax deductions are more than that of taxable income, which means negative income—subtracting tax deductions from the taxable income results in a net operating loss for your business/company. 

What this article covers:

What is a Net operating loss?

Net operating loss is a tax credit that occurs when your business’s tax deductions exceed the taxable income in a year. As per your company’s situation, you can take the net operating loss and carry it forward for the future tax year (if you achieve a profit for the coming year) and decrease your tax liability overall. 

When you set up a new business, you may earn less or no money; in this case, the IRS offers tax relief in the form of net operating loss (NOL). This may seem like an adverse scenario, but the NOL also has tax advantages. As a business owner, you don’t owe any taxes for the year and might get a tax refund for the taxes paid, or you can also use the losses for a reduction in your future tax payments. 

Net operating loss is commonly incurred when a business faces loss during operation. Different organizations claim NOL according to their business situation, but there are certain limitations to claim NOL. Following are the causes that might contribute to claim NOL:

  • Natural disasters
  • Property damages
  • Business expenses
  • Losses due to casualties or theft
  • Moving expenses
  • Rental property

Depending on the losses, they can be carried back for two years according to the NOL year or can be carried forward for 20 years. By carrying the net operating losses forward or backward, these losses can be used for income tax returns from past or future years and overall reduce your tax liability.

How to calculate Net Operating Loss?

To calculate your net operating loss on a business expense sheet, you need to subtract deductions from adjusted gross income; if it results in a negative number, it is a net operating loss. The item is displayed on line 41 on Form 1040, U.S. Individual Income Tax Return.

Following are the steps to calculate the net operating loss for businesses:

Determine Eligibility

As per IRS rules and regulations, a business may claim the net operating loss on certain limitations for deductions, which include: expenses related to business or trade, moving or rental expenses, casualty or theft losses, and your work as an employee.

The S-corporations and partnership businesses are not applicable to claim the net operating loss as per IRS. Still, they can individually get tax returns for their share of the loss. However, pass-through businesses such as sole proprietorship are eligible to claim the net operating loss.

Rules for deduction

The use of net operating losses is subject to certain restrictions. The list of excluded items are:

  • Deduction for personal exemptions
  • The net operating loss deduction
  • Deduction for domestic production activities
  • Any net capital losses (when capital losses are more than capital gains)
  • Nonbusiness deductions over nonbusiness income
  • Section 1202 exclusion of the gain from the sale or exchange of qualified small business stock

Calculate the Net Operating Losses

In this step, you must identify whether you have any net operating loss this year. For example, if your business has earned a taxable income of $600,000, with tax deductions of $900,000 and a corporate tax of 40%, its net operating loss will be:

$600,000 – $900,000 = -$300,000

The amount calculated is in the minus form, which means no taxable income for this tax year.

But if we assume that the business earns profit next year and records a taxable income of $300,000, it will be taxed at the corporate tax rate. After applying the tax rate, it will have to pay $300,000 x 40% = $120,000 in taxes.

When the business has faced a net operating loss in the previous tax year, it can use that NOL for the current tax year to decrease the tax bill. The amount of net operating loss can also be used against the taxable income in previous years for a tax rebate.

Net operating loss carryback or carryforward

Set off the net operating loss in previous years. The net operating loss will typically be carried back to the two tax years previous to the NOL year and used to claim an automatic tax refund on any taxable income. The NOL for 2017, for instance, could be carried back to 2015 or 2016. 

The NOLs have a higher carryback time in some situations. If there are damages from fraud or theft, for example, losses in small business in connection with a federally reported occurrence or losses in connection with lawsuits for product responsibility. 

The remainder of the balance is subject to taxable taxes for up to 20 years. The option of exempting the carryback period is also open to businesses and can be accessed directly from the provider. This is worth considering if you’ve not paid taxes for the last two years.

The taxpayer will not deduct a portion of NOL until the 20-year period has expired. If you end up with several NOLs over the years, the order in which they have been produced must be decided. This decreases the probability of net losses in the twenty-year cycle not being used.

How Long Can You Carry Forward Net Operating Losses?

Twenty years after the NOL year you will continue net losses for tax purposes. The remainder of the NOL is 20 years old but has no worth. 

You would need to make a declaration in your NOL tax return to claim you are doing this if you wish to save the carrying time, regardless of the sum of your net operating losses.

What Is a Net Operating Loss Deduction in Accounting?

Net operating losses are listed as company properties as such losses decrease taxable revenue. The losses are known as deferred tax assets and are included in the balance sheet under non-current assets. 

Measuring net operating losses is important as they provide potential tax relief for companies, particularly startups that have not begun making money. The theory is that if the corporation receives revenue, it owes taxes, and if it doesn’t, there will be some relief. The net operating loss is also a profitable asset.

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