Net Operating Losses
Understanding net operating losses can be confusing. For example, who can claim a net opertating loss (NOL)? How do you know if you have a net operating loss (NOL)? What can cause an NOL. How is it computed? And how do you claim an NOL deduction?
Read on to get the answers.
By the way, you don't have to be in business to have an NOL. There are several items that can cause an NOL, such as casualty and theft losses, but business losses are the most common cause.
Who Can Claim a Net Operating Loss?
The following can claim a net operating loss:
- Individuals (you don't have to be in business to claim a net operating loss)
- Owners of sole proprietorships
- Owners of pass through entities
- Partners of a partnership
- Members of a limited liability company
- Shareholders of an S corporation
- C corporations
- For a regular C corporation, an NOL is generally the amount by which total corporate expenses exceed gross corporate income.
- If a C corporation converts to an S corporation, any NOL carryovers it had at the time of conversion cannot be used. They can only be used if the S corporation goes back to being a C corporation.
If you incur a loss in your unincorporated business or profession, you may deduct the loss from your other sources of income reported on Form 1040.
For example, if you're self-employed and report a net loss of $5,000 on Schedule C, and have a spouse who earned $25,000 in wages from a job, you can deduct the $5,000 loss from the $25,000 in wages on Form 1040 (assuming you file a joint return). The result would be an adusted gross income (AGI) of $20,000.
Now, what happens if your business loss exceeds all your other income reported on Form 1040?
In this case, you may or may not have a net operating loss (NOL). This is where some of the confusion comes in.
How to Know if You Have a Net Operating Loss
The first thing you must do before even worrying about NOLs, is complete your individual income return, Form 1040. Then, check line 41 of Form 1040 (the line after itemized deductions and the standard deduction).
- If Line 41 has a negative number, this is your first clue of a possible net operating loss.
- If line 41 has a positive number, you do NOT have an NOL.
Form 1040NR, check line 39 for a negative number.
Estates and trusts — see the instructions for Form 1041, line 22, for information about taxable income and NOLs.
Keep in mind, a negative balance on line 41 (line 39 for Form 1040NR) is just a clue as to whether you actually have an NOL.
So how do you know if you actually have an NOL?
After completeing your income tax return, you must then complete Form 1045, Application for Tentative Refund.
By completing Form 1045 you will determine two things:
- If you actually have an NOL, and if you do,
- its amount .
What Can Cause an NOL?
Although a business loss is the most common cause of an NOL, there are other items that may create one.
- Casualty and theft losses, including property used for personal purposes. Casualty and theft losses are treated as business losses for NOL purposes. In other words, you don't have to be in business to have an NOL.
- Moving expenses to a new job location
- Deductible job-related expenses, such as travel and entertainment, the cost of work clothes, and union dues.
- Loss on the sale of small business investment company (SBIC) stock.
- A Loss incurred on Section 1244 stock
- Your share of a partnership or S corporation operating loss.
An NOL may NOT include:
- A net operating loss carryback or carryover from any year
- Deductions for personal exemptions
- A self-employed person's contribution to a Keogh plan
- An IRA deduction
- Capital losses that exceed capital gains
- Excess nonbusiness deductions over nonbusiness income and nonbusiness net capital gain
NOL Carryback and Carry Forward
You have the option of carrying back an NOL two years or waiving the carryback period and simply carrying the NOL forward up to 20 years.
If you carry back an NOL two years but do not use it up in those two years, you carry the remaining NOL forward up to 20 years.
Recomputing your tax liability in the carryback year:
When you carry back an NOL, you recompute your tax liability for the carryback year by reducing taxable income in that year by the amount of the NOL you caried back. This will reduce the original tax liability for that year and should result in refund of excess taxes paid for that year.
Carrying an NOL forward:
When carrying an NOL forward, the tax liability for the year to which the NOL is carried reduces the taxable income of that year, thereby reducing that year's tax liability.
More than one NOL:
If you carry more than one NOL to the same tax year, your NOL deduction is the total of all carrybacks and carryovers to that year.
If an NOL exceeds taxable income in the year to which it is carried, the excess amount is carried over to the following year.
Waiving the Carryback Period
You can choose not to carry back your NOL. If you make this choice, then you can use your NOL only in the 20-year carryforward period. (This choice means you also choose not to carry back any alternative tax NOL)
To make this choice, attach a statement to your original return filed by the due date (including extensions) for the NOL year (the year the NOL occurred). This statement must show that you are choosing to waive the carryback period under section 172(b)(3).
If you filed your original return on time but did not file the statement with it, you can make this choice on an amended return filed within 6 months of the due date of the return (excluding extensions). Attach a statement to your amended return, and write the following at the top of the statement: “Filed pursuant to section 301.9100-2.”
Once you choose to waive the carryback period, it is generally irrevocable. If you choose to waive the carryback period for more than one NOL, you must make a separate choice and attach a separate statement for each NOL year.
If you do not file this statement on time, you cannot waive the carryback period.
Three and Five-year Carryback Periods
An NOL that is caused by a casualty or theft loss may be carried back three years even if the loss involved property used for personal use. A qualified small business NOL attributable to a Presidentially declared disaster may also be carried back three years.
Farmers may carry back an NOL five years
A C corporation is not a pass-through entity, and therefore, a net operating loss may only be deducted from corporate income of other periods on Form 1120. In other words, C corporation net operating losses are not passed through to shareholders, they are deducted at the corporate level.
Pass-through entities include:
- Sole proprietorships
- S corporations
- LLCs (where no election was made for the LLC to be taxed as a C corporation).
How to Claim and NOL Deduction
If you have not already carried the NOL to an earlier year, your NOL deduction is the total NOL.
If you have carried the NOL to an earlier year, and it was not used up, carry over the remaining NOL to the next year.
More than one NOL:
If you carry more than one NOL to the same year, your NOL deduction is the total of these carrybacks and carryovers.
If your NOL is greater than the taxable income of the year you carry it to (figured before deducting the NOL), you generally will have an NOL carryover to the next year. See How To Figure an NOL Carryover later.
Deducting an NOL Carryback
Form 1045, Application for Tentative Refund
Carrying back an NOL will generally result in a refund. You can apply for a quick refund by filing Form 1045 (rather than filing Form 1040X).
Keep in mind, Form 1045 results in a tentative adjustment of tax in the carryback year. This means, if the IRS refunds or credits an amount to you from Form 1045 and later determines that the refund or credit is too much, the IRS may assess and collect the excess immediately.
Generally, you must file Form 1045 on or after the date you file your tax return for the NOL year, but not later than one year after the end of the NOL year. If the last day of the NOL year falls on a Saturday, Sunday, or holiday, the form will be considered timely if postmarked on the next business day.
For example, if you are a calendar year taxpayer with a carryback from 2015 to 2013, you must file Form 1045 on or after the date you file your tax return for 2015, but no later than January 2, 2017.
Form 1040X, Amended U.S. Individual Income Tax Return:
If you do not file Form 1045, you can file Form 1040X to get a refund of tax because of an NOL carryback. Generally, file Form 1040X for the carryback year within 3 years after the due date, including extensions, for filing the return for the NOL year.
For example, if you are a calendar year taxpayer, you must generally file a claim for refund because of an NOL carryback from 2013 by April 17, 2017 (3 years after the due date for the NOL return).
Form 1041, U.S. Income Tax Return for Estates and Trusts:
Estates and trusts that do not file Form 1045 must file an amended Form 1041 (instead of Form 1040X) for each carryback year to which NOLs are applied.
Use a copy of the appropriate year's Form 1041, check the Amended return box, and follow the Form 1041 instructions for amended returns. Include the NOL deduction with other deductions not subject to the 2% limit (line 15a).
Deducting an NOL Carryforward
Form 1040 and Form 1040NR:
If you carry forward your NOL to a tax year after the NOL year, list your NOL deduction as a negative figure on the Other income line for Form 1040, line 21, or Form 1040NR, line 21.
You must attach a statement that shows all the important facts about the NOL. Your statement should include a computation showing how you figured the NOL deduction. If you deduct more than one NOL in the same year, your statement must cover each of them.
Estates and Trusts:
Estates and trusts include an NOL deduction on Form 1041, line 15a, Other deductions not subject to the 2% floor.
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- Return to the Business Deductions Table of Contents to find related links