What Is A Net Operating Loss (NOL)?
When business deductions exceed business income, a net operating loss (NOL) may occur. A taxpayer can use an NOL to offset taxable income from other tax years.
Calculating a Net Operating Loss
An NOL must be caused by losses from business sources. You must recalculate the taxable loss for the year excluding all nonbusiness source income and deductions.
Some specific points in calculating NOL:
- You cannot use NOLs from other years to calculate the current year's NOL
- Rental real estate activities are considered business source income or loss
- State and local income taxes should be prorated between business source taxable income and nonbusiness source taxable income
Technical Note: At-risk rules and passive activity rules may limit an NOL deduction.
Caution: Special rules apply if you're subject to the alternative minimum tax (AMT).
Capital Gains and Losses
You can deduct nonbusiness capital losses to the extent of nonbusiness capital gains. You can deduct business capital losses to the extent of business capital gains. You can deduct any remaining business capital losses to the extent that nonbusiness capital gains exceed the sum of nonbusiness capital losses and nonbusiness deductions.
Using the NOL Deduction
The procedure for carrying back and carrying over an NOL depends largely on whether your NOL was incurred before August 6, 1997, after August 5, 1997 and before 2018, in a tax year ending in 2001 or 2002, in a tax year beginning or ending in 2008 or 2009, or (generally) in a tax year after 2017. The general rule in all cases is that you must carry back to prior tax years (if any) before carrying over to future tax years. You can, though, make an irrevocable election to forgo the carryback years (see below).
NOLs Before August 6, 1997
You could carry back the NOL to the third preceding tax year before the NOL year. If the NOL wasn't completely used up, you carry it over for up to 15 years after the NOL year.
Most NOLs After August 5, 1997 And Before 2018
You carry back the NOL to the second preceding tax year before the NOL year. If the NOL isn't completely used up, you carry it over for up to 20 years after the NOL year.
Certain NOLs After August 5, 1997 And Before 2018
For eligible losses, you carry back the NOL to the third preceding tax year before the NOL year. If the NOL isn't completely used up, you carry it over for up to 20 years after the NOL year. Eligible losses include casualty and theft losses and losses attributable to presidentially declared disasters sustained by farmers and small businesses.
Certain NOLs Arising In A Tax Year Ending In 2001 or 2002
The Job Creation and Worker Assistance Act of 2002 temporarily extended the two-year carryback period (and the three-year carryback period for NOLs arising from casualty and theft losses of individuals or attributable to certain presidentially declared disaster areas) to five years for taxpayers who have NOLs for any taxable year ending during 2001 or 2002.
Certain NOLs Arising In Tax Year Beginning or Ending in 2008 or 2009
The American Recovery and Reinvestment Act of 2009 allowed eligible small businesses to elect to extend the general two-year net operating loss (NOL) carryback period for 2008 net operating losses to three, four, or five years. An eligible small business was defined as a taxpayer meeting a maximum $15,000,000 gross receipts test. The provision applied to an eligible taxpayer's NOL for any taxable year ending in 2008, or if elected by the taxpayer, the NOL for any taxable year beginning in 2008. However, the election was allowed only with respect to one taxable year.
The Worker, Homeownership, and Business Assistance Act of 2009 provides for an election similar in nature to the NOL carryback provision in the American Recovery and Reinvestment Act:
- Businesses may elect to extend the general two-year NOL carryback period to three, four, or five years. The election is not limited to businesses that meet a specified gross receipts test.
- The election can be used for an NOL for a taxable year beginning or ending in either 2008 or 2009. The election can be used for only one year, however.
- Under the terms of the election, NOLs carried back five years would be able to offset up to 50 percent of the taxable income from the fifth year, but could offset all of the income from the other carryback years.
- Eligible small businesses that elected to carry back 2008 net operating losses under the provisions of the American
Recovery and Reinvestment Act of 2009 can still elect to carry back a 2009 NOL under the provisions of this Act. The Worker, Homeownership, and Business Assistance Act of 2009 specifically excludes certain taxpayers. For example, a business in which the Federal government acquired an equity interest pursuant to the Emergency Economic Stabilization Act of 2008 is not eligible for the election.
Certain NOLs Related To Hurricane Katrina or the Gulf Opportunity (GO) Zone
The Gulf Opportunity (GO) Zone Act of 2005 provides a special five-year carryback period for NOLs to the extent of certain specified amounts related to Hurricane Katrina or the GO Zone. The amount of the NOL that is eligible is limited to the aggregate amount of the following deductions:
- Qualified GO Zone casualty losses
- Certain moving expenses
- Certain temporary housing expenses
- Depreciation deductions with respect to qualified GO Zone property
- Deductions for certain repair expenses
The special carryback period applies to losses paid or incurred on or after August 28, 2005 and before January 1, 2008. Taxpayers can irrevocably elect out of this special treatment.
Caution: This provision does not apply with respect to any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises. This provision also does not apply with respect to any gambling or animal racing property
Tip: Public utilities in the Katrina GO Zone are eligible for a 10-year carryback on casualty losses, and certain small timber producers in the Katrina, Wilma, and Rita GO Zones are eligible for a "farming" five-year carryback of specified timber NOLs.
Tip: Under the Food, Conservation, and Energy Act of 2008 (otherwise known as the Farm Bill), the five-year NOL carryback period for certain amounts related to Hurricane Katrina or the GO Zone, see above, applies to the Kansas Presidential Disaster Area. The Kansas Presidential Disaster Area is the area declared and determined by the President to warrant individual or individual and public assistance from the federal government with respect to damages attributable to storms and tornados that began May 4, 2007. (Counties affected include Barton, Clay, Cloud, Comanche, Dickinson, Edwards, Ellsworth, Kiowa, Leavenworth, Lyon, McPherson, Osage, Osborne, Ottawa, Phillips, Pottawatomie, Pratt, Reno, Rice, Riley, Saline, Shawnee, Smith, and Stafford.)
Tip: Under the Emergency Economic Stabilization Act of 2008, the five-year NOL carryback period is also applied to the Midwestern Disaster Area. The Midwestern Disaster Area is generally the area (A) with respect to which a major disaster has been declared by the President on or after May 20, 2008 and before August 1, 2008, under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of severe storms, tornados, or flooding occurring in any of the States of Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin, and (for most provisions) (B) determined by the President to warrant individual or individual and public assistance from the Federal Government under such Act with respect to damages attributable to such severe storms, tornados, or flooding.
NOLs After 2017
In general, you can't carry back the NOL to any year before the NOL year. (You can carry back certain farming loss NOLs to the second preceding tax year before the NOL year.) If the NOL isn't completely used up, you carry it over indefinitely for any number of years after the NOL year until it is used up. The maximum NOL deduction allowed for a year is equal to the lesser of (1) the aggregate carryovers or carrybacks to the year, or (2) 80 percent of taxable income (computed without regard to the NOL deduction).
Electing To Forgo Carrybacks
You can elect to forgo the carryback years (if any) and use the NOL only in the succeeding carryover years after the NOL year. The election is irrevocable and must be made on a timely filed return (including extensions) for the NOL year. To make this election, attach the following statement to the return: "The taxpayer elects to forgo the net operating loss carryback period under Section 172(b) (3) of the Internal Revenue Code."
Caution: Taxpayers subject to the extended five-year carryback period under the Job Creation and Worker Assistance Act of 2002, as explained above, have one opportunity to elect out of the five-year carryback period. The election is irrevocable.
Forms and Worksheet
For carryback years, you may use Form 1045 or Form 1040X to claim a refund of taxes from the NOL deduction. You must attach a worksheet showing the NOL calculation to Form 1045 or Form 1040X. For carryover years, attach the worksheet to the carryover year return and enter the NOL deduction as a negative number on the "Other Income" line of Form 1040.
Effects on Taxable Income in Carryback Year
You need to recompute certain items in your carryback year return. First, you must recompute medical, casualty, and theft losses and miscellaneous deductions subject to the 2 percent adjusted gross income (AGI) limitation to reflect the NOL carryback. You also need to recompute tax credits. You do not, however, need to recompute either charitable contributions or the self-employment tax of a carryback year.
NOL Carryover Years
If an NOL isn't fully absorbed in the year to which it is carried, you need to calculate the unused amount that you can carry forward to the next year. For purposes of calculating the unused NOL to be carried forward, you must modify taxable income for the following:
- The NOL deductions for the intervening year is computed by taking into account only carrybacks and carryovers from tax years preceding the loss year.
- For taxpayers other than corporations, net capital losses are not deductible.
- Personal exemptions are not allowed.
- Any item affected by the modifications to AGI due to the changes in the first two items must be recomputed. This includes the IRA deduction, medical expenses, charitable contributions, casualty and theft losses, and miscellaneous deductions subject to the 2 percent AGI limitation.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.