How to Calculate Net Operating Loss for Corporations

What is an NOL deduction and why is it allowed?

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.

The purpose of the net operating loss (NOL) deduction is to relieve inequities caused by the determination of the income tax based on an annual accounting period. This federal tax planning strategy 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.

In this article, we’ll cover the NOL formula, deduction calculation, and how recent changes to carryback and carryforward rules may impact your corporate tax planning strategy.

[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. Download the NOL Carryback Flowchart to determine the carryback period for your context.]

Which taxpayers are allowed to deduct net operating losses?

Allowed to deduct NOLs:

• 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 to deduct NOLs:

• Partnerships
• S corporations
• Regulated investment companies
• Corporations subject to the accumulated earnings tax
• Common trust funds

Net operating loss formula

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. Which modifications must be made in calculating a net operating loss depends on whether the taxpayer is a corporation or an individual. For individuals, a net operating loss may also be attributable to casualty losses.

Net operating loss for individuals

An individual’s NOL 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.

Net operating loss for corporations

A corporation’s 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.
• The deduction for foreign-derived intangible income is disallowed.

NOL carryback and carryforward rules

The NOL for any tax year is determined under the law applicable to that year. Thus, assume that an NOL 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.

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

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

How many years can an NOL be carried forward?

The carryback and carryforward periods determine the maximum number of taxable years in which a taxpayer may offset taxable income with a given NOL.

[The length of a carryback period depends on multiple factors. Download our NOL Carryback Flowchart to determine the applicable carryback period.]

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.

NOL 80% carryforward limitation

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

• The aggregate of the net operating loss carryovers to such year, plus the net operating loss carrybacks to such year
• 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 Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily repeals the 80% limitation for NOLs generated in tax years beginning before 2021. State NOL allowances may differ from federal.

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 Jan. 1, 2021.

Under a longstanding provision, IRC §172(b)(3), a corporation can elect to waive this five-year carryback. A corporation making an election under §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.