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Updated for 2012
For tax purposes, the terms business loss and a net operating loss are not defined the same way when applied to C corporations and to individuals.
For tax purposes, when a C corporation reports a net loss (e.g., expenses exceed income) on Form 1120 the loss is referred to as anet operating loss.
A net operating loss is used to reduce corporate income of other years. Shareholders don't get to deduct C corporation net losses on their own tax return.
Individuals may also incur a net operating loss when preparing their individual income tax return. A net operating loss may occur when certain deductions exceed income reported on Form 1040.
For example, among the variety of items that may cause a net operating loss, the most common cause is a net business loss incurred by a pass-through entity in which the individual has an ownership interest.
Pass-through entities include:
Pass-through entities do not pay federal income tax. However, there are some exceptions for older C corporations that converted to S corporation status.
Losses incurred by pass-through entities are passed through the entity to each owner. Each owner may deduct his/her share of the loss from other sources of income reported on his/her individual income tax return.
By reducing income from other sources reported on Form 1040 the taxpayer reduces his/her income tax liability.
If a net business loss exceeds all other income reported on Form 1040 a net operating loss will result. The net operating loss may be carried back to reduce income of prior years. It may also be carried forward.