Posted by David Macgregor

Net Operating Losses: The Basics

Net Operating Losses: The Basics

Many companies do not earn money, especially during the first year of operation. When this happens, the IRS offers entrepreneurs tax benefits in the form of a net operating loss (NOL). If you're not sure what an NOL is or don't know how to get the most out of it, read on. We will give a breakdown of everything you need to know about it.

Key Points:

    •    There is a net operating loss (NOL) if the deductions of a business exceed taxable profit.

    •    An NOL can benefit a business by reducing taxable income over the next few years.

    •    The Law on Tax Reductions and Employment has made significant changes to the NOL rules for fiscal years beginning in 2018.

    •    NOLs can now be transferred indefinitely until the full loss is recovered, but are limited to 80% of taxable income in any tax period.

    •    Section 382 limits the transfer that an enterprise can use if it acquires another enterprise with a previous NOL.

Net Operating Losses: The Basics

A net operating loss (NOL) occurs when a business receives more tax deductions than taxable profits in a given year. When entrepreneurs have an NOL, they don't have to pay tax for that year. Also, they can receive a refund of taxes paid in previous years or use the business losses to reduce their future taxable income.

Although the companies themselves cannot obtain tax exemption if they are transfer entities, such as sole proprietorships, partnerships, and corporations, their owners can apply net operating losses to individual tax returns. Corporations C are taxed at the business level, so their losses apply to corporate income tax returns.

How does the net operating loss (NOL) work?

Net operating losses (NOL) is used to reduce future tax payments. For example, suppose that ABC has taxable profit of $ 1,000,000 and tax deductions of $ 1,500,000. Its net operating loss is between $ 1,000,000 and $ 1,500,000 = - $ 500,000.

Company ABC is unlikely to have to pay the tax that year since it had no taxable income. But suppose that the following year, the company ABC earns much more and records a taxable income of $ 700,000.

If company ABC is taxed at a 40% tax rate, you will have to pay $ 700,000 x 40% = $ 280,000 in taxes. However, since you obtained an NOL the previous year, you can apply it to this year's tax account, reducing it considerably or up to $0. This is largely reliant on the jurisdiction in which ABC is located. ABC can also recover "NOL" and apply it to taxable income from previous years.

Why is the net operating loss (NOL) significant?

NOLs are essential because they create a future benefit for businesses. The general idea is that when a company makes money, it pays taxes; when you don't make money, you can get help. As a result, the NOLs themselves are valuable resources. Companies sometimes buy from other companies exclusively for their NOLs.

Laws regarding the application of the NOL vary by state, but in general, an NOL in the past two or three years may be applied up to 20 years in the future upon its expiration. There are rules and exceptions for almost all circumstances; therefore, it is best to consult the IRS or a qualified tax advisor when calculating and applying the NOL.

New Changes To Tax Legislation For Net Operating Losses

The law on tax reduction and employment affect the calculation of net operating losses from 2018.

    •    No NOL Carryback is allowed: Prior to 2018, there was the option to transfer an NOL in the coming years or before to reduce taxes. However, it changed in 2018. Now, you will only be able to transfer a single NOL for one year.

    •    NOL Limited: A deduction for operating loss net of tax cannot exceed 80% of taxable income in a year. If your NOL exceeds 80% of your taxable income for one year, you will have a transfer next year.

    •    Limited Excess Trade Losses: During a year, losses exceeding a certain threshold cannot be deducted. Losses more significant than this amount are called excess losses, the sum by which the total of business deductions is greater than the whole of corporate gross income and business capital gains plus $ 250,000 (or $ 500,000 in the case of an average return). Excess trade losses can be carried over to a later year.

Net Operating Losses Carryback

Carrying over an NOL forward or backward will result in losses for tax returns from past and future years. The advantage of this is that an NOL can reduce its tax liability.

The year in which the net operating loss occurs is known as the NOL year. If you have an NOL, you can take it up to two years before the NOL year. These two years are known as the repayment period. If the net operating loss occurs after theft or other accident, you may be eligible for a three-year reimbursement period.

Taxpayers wishing to recover net operating losses can apply them to a previous income tax return by completing an amended tax return using the IRS 1040x form. If something remains, you need to run it and apply it on a future tax return.

If you want to receive the refund faster, you can use Form 1045 instead of Form 1040x. This form, called an interim refund request, will guarantee that your tax refund will be received within 90 days. But, according to IRS rules, this form must be submitted within one year from the NOL.

Net Operating Loss Carryforward

If you do not wish to carry your NOL backward, you can carry it forward to any time over 20 years. It is worth considering, especially if you have not paid your taxes in the past two years. After 20 years, all remaining NOLs are canceled.

If you wish to waive the repayment period and transfer the NOL over time, you must include a statement for the NOL year, indicating that you are doing so. If you file the tax return without attaching an account statement, you can still file a modified tax return within six months of the tax due date (this period does not take into account deposit extensions). You are advised to write "filed pursuant to section 301.9100-2" at the top of the income tax return sent with the amended income tax return.

When calculating your NOL, you should ignore certain deductions. For example, entrepreneurs who do not pay corporate tax should exclude personal exemptions and net capital losses (when capital losses exceed capital gains).


When you have a business, losing money is not the end of the world. The possibility of using a loss transfer technique or a loss transfer can reduce some of the tax burdens.

If you have an NOL, you should think carefully before deciding what to do with it. After all, once the refund period is canceled, your decision cannot be reversed. 

David Macgregor
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