Understanding Net Operating Loss (NOL) Deductions | IRS.gov

A net operating loss (NOL) for income tax purposes is when a company’s allowable deductions exceed the taxable income in a tax period. When a company’s deductibles are greater than its actual income, the Internal Revenue Service (IRS)How to Use the IRS.gov WebsiteIRS.gov is the official website of the Internal Revenue Service (IRS), the United States’ tax collection agency. The website is used by businesses and allows the company to use the loss to reduce previous years’ taxes or to carry it forward to offset future years’ profits. It is a benefit that helps reduce the tax liability of the business.

Common Reasons for Net Operating Loss

One of the most common periods for incurring net operating losses occurs when companies are in their start-up phase. Such companies often are spending more money than they are taking in, in order to generate future sales or income. Also, NOLs are commonly seen in businesses that are cyclicalCyclical IndustryA cyclical industry refers to an industry whose revenue generation capabilities are tied to the business cycle. In other words, a cyclical in nature.

An example is a mining business, where they may generate large profits in one period, incur an NOL in the next, but make back the profit again in the following period. In this case, they can carry forward the second year NOL to offset taxes in the third year.

When companies report an NOL, three common things can happen:

1. The company does not owe any taxes for the current period;
2. The company can get a refund for previously paid taxes; and
3. The company can carry forward its business losses to lower future taxable income.

NOL Carryback

The benefit of carrying an NOL carryback is to get a refund on a company’s previous years’ tax liability. The year that the NOL occurs will be identified as the NOL year. From that point in time, the company can carry the amount back to the previous two years.

However, companies can carry the amount back for three years under special circumstances, such as losses due to theft. It is done by filing an amended return (using IRS Form 1040x).

NOL Carryforward

In case the company does not want to carry the NOL back or cannot due to prior years NOLs, it can choose to carry it forward and apply them to future taxable income for up to a 20-year period. For an NOL carryforward, the company generates a schedule to track all its cumulative losses, which are used to reduce profits in future years until the balance in the NOL carryforward is zero.

Related Readings

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In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Deferred Tax LiabilityDeferred Tax Liability/AssetA deferred tax liability or asset is created when there are temporary differences between book tax and actual income tax.
• Income Tax PayableIncome Tax PayableIncome tax payable is a term given to a business organization’s tax liability to the government where it operates. The amount of liability will be based on its profitability during a given period and the applicable tax rates. Tax payable is not considered a long-term liability, but rather a current liability,
• Net Operating Income (NOI)Net Operating Income (NOI)Net Operating Income (NOI) is the value of a revenue-generating property when the total operating expenses and losses from vacant premises are
• Taxable IncomeTaxable IncomeTaxable income refers to any individual's or business’ compensation that is used to determine tax liability. The total income amount or gross income is used as the basis to calculate how much the individual or organization owes the government for the specific tax period.