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Net Operating Losses

Last updated on Jan. 26, 2023

The purpose of the net operating loss deduction is to relieve inequities caused by the determination of the income tax based on an annual accounting period. The net operating loss deduction effectively averages a taxpayer’s income and losses over a period of years, thereby reducing the tax disparity that would otherwise exist between businesses with stable incomes and businesses with fluctuating incomes.

What is a net operating loss?

A net operating loss for a taxable year is equal to the excess of deductions over gross income, computed with certain modifications. Because of these modifications, a net operating loss approximates a taxpayer’s actual economic loss from business-related expenses. For individuals, a net operating loss may also be attributable to casualty losses. Which modifications must be made in calculating a net operating loss depends on whether the taxpayer is a corporation.

The net operating loss for any tax year is determined under the law applicable to that year. Thus, assume that a net operating loss is incurred in a loss year. That net operating loss is carried back or forward to earlier or later tax years in which it forms part of the net operating loss deduction. For purposes of determining the amount of the net operating loss deduction, the law of the year in which the net operating loss is ultimately deducted, rather than the law of the loss year, is controlling.

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Download: Flow Chart to Determine NOL Carryback Period

The lengths of the carryback period depends on multiple factors. Use our flow chart to determine the applicable carryback period.

How is net operating loss calculated?

An individual’s net operating loss is equal to the taxpayer’s deductions less gross income, modified as follows:

  •  the NOL deduction is disallowed for an NOL carryback or carryover from another tax year
  •  the deduction of business and nonbusiness capital losses is limited to the amount of capital gains
  •  the deduction of nonbusiness deductions is limited to the amount of nonbusiness income
  •  the exclusion for capital gains from small business stock under IRC §1202 is not allowed
  •  the deduction for qualified business income is disallowed

A corporation’s net operating loss (NOL) is equal to the corporation’s deductions less gross income, modified as follows:

  •  the NOL deduction is disallowed for an NOL carryback or carryover from another tax year;
  •  the dividends-received deductions under IRC §243 and IRC §245 are computed without regard to the aggregate limitations that normally limit these deductions; and
  • the deduction for foreign-derived intangible income is disallowed

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What amount is deductible as a net operating loss (NOL)?

The net operating loss deduction allows a taxpayer with a loss in one year and income in another year to pay tax on the net amount as if it were earned evenly over the same period, thus reducing the inequity that would otherwise result from use of annual accounting periods and the progressive rate structure.

Generally, for a tax year beginning in 2018 or later, a NOL deduction for any tax year equals the lesser of:

  • the aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year; or
  • 80% (or 100% for NOLs generated in tax years beginning before 2021) of taxable income computed without regard to the allowable NOL deduction

The 80% limitation applies to REIT NOLs, but it does not apply to losses of non-life insurance companies.

The CARES Act temporarily repeals the 80% limitation for NOLs generated in tax years beginning before 2021. State NOL allowances may differ from federal.

Determine the amount of the net operating loss deduction in four steps:

Step 1: Determine the amount of a net operating loss.
Step 2: Ascertain the carryback and carryover periods.
Step 3: Calculate the net operating loss carryback or carryover.
Step 4: Determine the net operating loss deduction.

Learn more: Accounting for NOLs under ASC 740

Understand how NOLs and tax credits affect the ASC 740 provision for income taxes and how tax provision software can help account for NOLs and credits.

What is an NOL carryforward or carryback?

The carryback and carryforward periods determine the maximum number of taxable years in which a taxpayer may offset taxable income with any particular net operating loss.

NOLs arising in tax years beginning in 2018, 2019, and 2020 may be carried back for a period of five years and carried forward indefinitely. A taxpayer may elect to forego the carryback. Generally, an NOL arising in a tax year beginning in 2021 or later may not be carried back and instead must be carried forward indefinitely. However, farming losses arising in tax years beginning in 2021 or later may be carried back two years and carried forward indefinitely. NOLs of non-life insurance companies arising during these years may also be carried back two years and carried forward 20 years.

The net operating loss must first be carried to the earliest of the taxable years for which it is allowable as a carryback or carryforward. If the net operating loss is not fully absorbed by the taxable income of that earliest taxable year as limited under §172(a)(2), it is then carried to the next earliest taxable year. The process is repeated until the net operating loss is completely absorbed. Any net operating loss remaining after the carryforward period ends (in cases where the carryover period is not indefinite) is not deductible.

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Download: Flow Chart to Determine NOL Carryback Period

The lengths of the carryback period depends on multiple factors. Use our flow chart to determine the applicable carryback period.

Which taxpayers are allowed to deduct net operating losses?

Allowed:

  •  individuals
  •  C corporations
  •  estates and trusts
  •  exempt organizations with unrelated business taxable income
  • participants in a common trust fund
  •  insurance companies
  •  personal holding companies, under certain circumstances

Not allowed:

  •  partnerships
  •  S corporations
  •  regulated investment companies
  •  corporations subject to the accumulated earnings tax
  •  common trust funds

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How did the CARES Act affect NOLs for corporations?

Prior to the CARES Act, NOLs arising in years after 2017 were not allowed to carry back, had an unlimited carryforward period, and were limited to 80% of taxable income. The CARES Act retroactively modified and expanded those rules. Under the CARES Act, NOLs arising in years beginning 2018 through 2020 may be carried back five years and the 80% NOL deduction limit is temporarily lifted for NOL carryforwards to years beginning before January 1, 2021.

Under a long-standing provision, IRC §172(b)(3), a corporation can elect to waive this five-year carryback. A corporation making an election under section 172(b)(3) can still take advantage of the temporary changes to the 80% limitation rules and offset 100% of taxable income with NOL carryforwards that would otherwise be subject to the limitation.

There are complicated interactions with other rules, particularly for multinational corporations. Those corporations that repatriated income under IRC §965 between 2016 and 2019 may not offset inclusion income under a deemed election under IRC §965(n). However, CARES provides for an election to skip IRC §965 years while still applying the NOL carryback to other years.

The impact on other tax attributes needs to be carefully considered as well. For example, general business credits (GBCs) and foreign tax credits (FTCs) may be freed up by the NOL carryback and may now carry back or forward to other years. The alternative minimum tax (AMT) may also come into play, not only with a minimum tax but with the limitation for general business credits as well.

The separate return year rules come back into play with consolidated return groups. NOLs may need to be allocated to a departing consolidated return member.

These new rules provide many planning opportunities to provide an infusion of cash to cash-strapped businesses, but it is critical to evaluate all the possible scenarios to avoid any unintended negative consequences.

Did the Covid-Related Tax Relief Act further impact NOLs?

The Covid-Related Tax Relief Act allows farmers who elected a two-year NOL carryback before the CARES Act to elect to retain that two-year carryback rather than claim the five-year carryback provided in the CARES Act. It also allows farmers who previously waived an election to carry back an NOL to revoke the waiver. This provision applies retroactively as if included in the CARES Act.

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In Brief: Claiming Rapid Refunds for Corporate Net Operating Losses Under CARES

The CARES Act contains changes to NOLs, business interest expense deductions, and refundable minimum tax credit (MTC), which give rise to a significant carryback claim opportunity.

Key IRC Sections

Bloomberg Tax Research is pleased to offer the full text of the current Internal Revenue Code free of charge. This site is updated continuously and includes Editor’s Notes written by expert staff at Bloomberg Tax indicating when a section has been repealed or when there is a delayed effective date, allowing you to see the current and future law. Links to related code sections make it easy to navigate within the IRC.


§172

Net Operating Loss Deduction

§382

Limitation On Net Operating Loss Carryforwards And Certain Built-In Losses Following Ownership Change

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Portfolio 539-4th: Net Operating Losses – Concepts and Computations

This Bloomberg Tax Portfolio examines the background and rationale of IRC §172, provides an overview of the NOL deduction and eligibility, and furnishes a step-by-step explanation of the computations required in applying IRC §172.

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Portfolio 780-4th: Net Operating Losses and Other Tax Attributes

This portfolio analyzes net operating loss and credit carryovers during and after a change of corporate ownership.

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NOL Carrybacks and the CARES Act

This presentation reviews the impact of the CARES Act on NOLs and potential consequences of carrying back NOLs under the CARES Act, including international tax, state tax, and financial accounting effects.

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