How a Net Operating Loss Could Reduce Your Future Tax Bill

Even well-run businesses have down years. Revenue dips, unexpected expenses pile up, or an economic shift hits harder than anticipated. What many business owners don’t realize is that a loss year doesn’t have to be a total write-off. The federal tax code includes provisions that may allow those losses to reduce your tax burden in future years. Understanding how this works can make a real difference in your long-term tax planning.

What Is a Net Operating Loss?

A net operating loss (NOL) occurs when your allowable tax deductions exceed your income for the year. The NOL deduction exists to create some fairness between businesses with steady, predictable income and those whose revenue fluctuates year to year, allowing businesses to average income and losses over time rather than paying taxes based on a single year’s snapshot.

You may be eligible for the NOL deduction if your losses stem from business operations (reported on Schedules C, F, or K-1 from a partnership or S corporation), casualty or theft losses from a federally declared disaster, or rental property reported on Schedule E. Individual taxpayers and C corporations can claim the NOL deduction directly. Partnerships and S corporations are generally not eligible at the entity level. Still, individual partners and shareholders can use their share of the business’s income and deductions to calculate their own NOL.

A few items are specifically excluded from NOL calculations, including capital losses that exceed capital gains, nonbusiness deductions that exceed nonbusiness income, and the Section 199A qualified business income deduction, among others.

How the NOL Rules Changed and What They Mean Now

The Tax Cuts and Jobs Act (TCJA) significantly changed how NOLs work. Before the TCJA, businesses could carry losses back two years to offset prior income and receive a refund, carry them forward up to 20 years, and use them to offset up to 100% of taxable income. Under current rules, carrybacks have been eliminated for most businesses (with a limited exception for certain farm losses), carryforwards are now allowed indefinitely, and the deduction is capped at 80% of taxable income in the year it’s applied. If an NOL carryforward is larger than your taxable income in a given year, the remaining balance carries over to the next year, and multiple NOLs must be applied in the order they were incurred.

The Excess Business Loss Limitation

There’s an additional layer to be aware of for noncorporate taxpayers. Under a rule that took effect in 2021, business losses can only offset business-related income or gain up to an inflation-adjusted threshold — $313,000 for single filers and $626,000 for married couples filing jointly in 2025. Any losses beyond that threshold are treated as an NOL carryforward, which then becomes subject to the 80% income cap. This effectively reduces the tax value of larger losses and limits how quickly they can be used. This limitation is currently set to apply through 2028 under the Inflation Reduction Act, which extends it beyond its original TCJA expiration date of December 31, 2026.

Planning Makes a Difference

NOLs interact with other deductions, credits, and limitations in ways that can quickly get complicated. The rules around ordering, carry-forwards, and the excess business loss limitation all require careful coordination to get the most out of a bad year. Proactive planning, ideally before you file, gives you the best chance of maximizing the benefit. 

If you’ve experienced a loss in the past year or think you might be heading into one, reach out to CJG Partners. We can help you understand your options and build a strategy that works in your favor.