What Is a Net Operating Loss (NOL)? Carryforward Rules Explained

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A net operating loss (NOL) is the tax loss a business has when its allowable deductions exceed its gross income for a tax year, after the adjustments the tax code requires. Under U.S. federal law (Internal Revenue Code Section 172), that loss does not simply vanish at year end. It becomes an NOL carryover that can reduce taxable income in other years. For losses arising after 2017, that generally means carrying the loss forward indefinitely, with the deduction capped at 80% of taxable income in tax years beginning after 2020.

What Is a Net Operating Loss?

Startups are a typical source of NOLs: they often spend heavily on staff, equipment and development before revenue catches up. Businesses in cyclical industries such as construction or retail can also swing between profitable and unprofitable years.

The tax code lets the loss move across years: the IRS allows it to be deducted against income from other years, so over a multi-year period the total tax paid comes closer to the tax on the business’s combined net income.

NOLs are not limited to corporations. Individuals, estates and trusts with business losses (for example, a sole proprietor reporting on Schedule C or a partner receiving a share of partnership losses) can also generate NOLs, although the calculation starts from a different figure for each type of taxpayer.

Tax NOL vs. accounting net loss

The bottom line of an income statement reports accounting net income or net loss under financial reporting standards. A tax NOL is calculated separately under the tax code, and the two figures often differ. A company can report an accounting profit while having a tax loss (for example, because of accelerated tax depreciation), or report an accounting loss while owing tax.

On the balance sheet, the expected future tax savings from an unused NOL are recorded as a deferred tax asset. If the company does not expect enough future taxable income to use the loss, accounting rules require a valuation allowance that reduces that asset. This is why NOLs appear in financial statement notes rather than as a line on the income statement.

How a Net Operating Loss Works

The NOL rules now depend heavily on when the loss arose. A business with losses from several years may hold two kinds of carryover at once, each with its own rules.

Losses arising in tax years beginning after 2017

• Carryforward period: indefinite. The loss stays available until it is used.
• Carryback: generally none. Farming losses can be carried back two years.
• Annual limit: for tax years beginning after 2020, the deduction for these losses is limited to 80% of taxable income remaining after pre-2018 NOLs are applied.

Losses arising in tax years beginning before 2018

• Carryforward period: 20 years.
• Carryback: under the old rules, two years.
• Annual limit: none. These carryovers can offset 100% of taxable income.

Insurance companies other than life insurers keep the older structure for their losses: a two-year carryback, a 20-year carryforward and no 80% limit.

The two-tier deduction formula

For a taxpayer subject to the 80% limit, the NOL deduction in a tax year beginning after 2020 cannot exceed:

1. Pre-2018 NOL carryovers, which can offset up to 100% of taxable income, plus
2. The lesser of (a) post-2017 NOL carryovers or (b) 80% of the taxable income remaining after the pre-2018 carryovers are applied.

The taxable income used for the 80% calculation is figured before the NOL deduction itself and before deductions under Section 199A (the qualified business income deduction) and Section 250. Because every loss must be matched to its origination year, businesses need to track each year’s NOL separately rather than as one running total.

Interpreting a net operating loss

An NOL carryover has value only if the business later earns taxable income. A large carryover tells you the business has accumulated past tax losses. It says nothing by itself about whether the business will become profitable. Its practical worth depends on the size of future taxable income, the tax rate that income would face, and limits such as the 80% cap and Section 382.

The removal of most carrybacks also changed the timing of the benefit. Under the old rules, a loss year could produce a quick refund of taxes paid in the two prior years. Now most businesses must wait for future profits to realize any tax saving, which matters for cash flow during the loss year itself.

Calculating a Net Operating Loss

The NOL is not simply revenue minus expenses. The calculation starts from the taxpayer’s income figure before any NOL deduction and then removes items that are not allowed in the computation. For individuals, estates and trusts, IRS Publication 536 sets out the steps, which broadly are:

1. Start with the relevant income figure from the tax return, before any NOL deduction. The starting line differs for individuals, estates and trusts, and corporations.
2. Add back NOL carryovers from other years. A prior year’s NOL cannot be used to create or enlarge the current year’s NOL.
3. Remove nonbusiness deductions that exceed nonbusiness income. For individuals, the NOL is meant to capture business losses, not an excess of personal deductions.
4. Remove capital losses that exceed capital gains. Net capital losses are subject to their own limits and do not count toward the NOL (see how capital gains tax treats gains and losses).
5. Remove the Section 1202 exclusion for gain on qualified small business stock.

If the adjusted figure is still negative, that amount is the NOL.

Hypothetical example: a business has $700,000 of gross income and $900,000 of allowable deductions. The starting point is $700,000 minus $900,000, or a $200,000 loss. If $30,000 of the deductions were nonbusiness deductions in excess of nonbusiness income, that amount is removed, and the NOL becomes $170,000. The adjustments almost always shrink the loss or leave it unchanged; they never make it larger.

Excess business losses

Noncorporate taxpayers face an additional rule before the NOL even arises. The excess business loss limitation caps how much net business loss an individual, estate or trust can deduct against other income (such as wages or investment income) in a year. For 2026, the threshold is $256,000, or $512,000 for joint returns. Business losses above the threshold are disallowed for that year and treated as an NOL carryover to later years. The Inflation Reduction Act of 2022 extended this limitation; it did not change the general NOL carryforward period or the 80% formula.

Example of a Net Operating Loss

A single post-2017 loss

A hypothetical startup, Daratech Solutions, has a $500,000 NOL in Year 1 (a tax year beginning after 2020). In Year 2, it has $400,000 of taxable income before the NOL deduction.

1. The full $500,000 carries forward with no expiration date.
2. The Year 2 deduction is capped at 80% of taxable income: $400,000 × 80% = $320,000.
3. Taxable income after the deduction: $400,000 − $320,000 = $80,000.
4. Remaining carryover: $500,000 − $320,000 = $180,000, available in later years under the same 80% cap.

Even with a carryover larger than its income, Daratech still owes tax on $80,000. Under the old rules, the full $400,000 could have been offset.

Mixing pre-2018 and post-2017 losses

A hypothetical corporation has $1,000,000 of taxable income before the NOL deduction (and before Sections 199A and 250, which do not apply here). It holds a $300,000 pre-2018 carryover that is still within its 20-year window and a $900,000 post-2017 carryover.

1. The pre-2018 carryover offsets 100% of income: $1,000,000 − $300,000 = $700,000 remaining.
2. The post-2017 limit is 80% of that remainder: $700,000 × 80% = $560,000.
3. The post-2017 deduction is the lesser of $900,000 or $560,000, so $560,000.
4. Total NOL deduction: $300,000 + $560,000 = $860,000.
5. Taxable income after the deduction: $1,000,000 − $860,000 = $140,000.
6. Remaining post-2017 carryover: $900,000 − $560,000 = $340,000.

Assuming the 21% federal corporate rate applies, the $860,000 deduction reduces federal tax for the year by $180,600. State tax is a separate calculation, because states set their own NOL carryforward periods and limits and do not all follow the federal rules.

How NOL Rules Have Changed

Before 2018

Before the Tax Cuts and Jobs Act (TCJA), the general rule allowed a two-year carryback and a 20-year carryforward, with no percentage cap.

Tax Cuts and Jobs Act of 2017

The TCJA changed the treatment of losses arising after 2017:

• It generally eliminated carrybacks, keeping exceptions for farming losses and insurance companies other than life insurers.
• It made most post-2017 NOLs carry forward indefinitely, while pre-2018 losses kept their 20-year periods.
• It limited deductions for post-2017 NOLs to 80% of taxable income.

The changes were projected to raise federal revenue, and they reduced the near-term benefit of losses for many businesses.

CARES Act of 2020

In response to the pandemic, the CARES Act temporarily relaxed the rules:

• NOLs arising in tax years beginning in 2018, 2019 and 2020 could be carried back up to five years.
• The 80% limit was suspended for tax years beginning before 2021.
• For tax years beginning after 2020, the two-tier formula described above took effect, giving pre-2018 carryovers full use and applying the 80% cap only to post-2017 losses.

Limitations of a Net Operating Loss

Section 382 after an ownership change

Section 382 limits the use of NOLs when a corporation goes through an ownership change: an increase of more than 50 percentage points in the stock owned by one or more 5% shareholders over a three-year testing period. After the change, the annual amount of pre-change NOL the corporation can use is generally capped at:

Annual limit = value of the corporation immediately before the change × long-term tax-exempt rate

Hypothetical example: a corporation worth $1 million changes ownership when the applicable rate is 5%. Its annual limit on pre-change NOLs is $1,000,000 × 5% = $50,000. If it holds $2 million of NOLs, using them all would take decades at that pace.

This rule is central in acquisitions of loss-making companies, including private equity and real estate deals. A buyer cannot use the target’s losses all at once against its own profits, so acquired losses are valued with the Section 382 cap in mind.

Other practical limits

• Expiration of older losses. Pre-2018 carryovers still expire after 20 years if unused.
• Partial offset. The 80% cap means a profitable year generally still produces some taxable income when only post-2017 losses are available.
• Consolidated groups. Corporations filing a consolidated return face further limits on losses a member brought into the group, known as the SRLY rules.

FAQs

The Bottom Line

Business owners, startup founders and buyers of loss-making companies need to understand how NOLs carry over, because a loss saves tax only when the business later earns taxable income. Tracking each year's loss separately matters, since the year it arose sets its expiration, carryback and 80% cap rules. Acquirers should value inherited losses with the Section 382 limit in mind, and state rules require their own calculation.