Definition
What is Net Operating Loss (NOL) Deduction?
Net Operating Loss (NOL) Deduction allows businesses to deduct a net operating loss from another tax year to offset taxable income. Essentially, a business that has experienced greater allowable tax deductions than taxable revenues within a year incurs an NOL. The IRS permits businesses to apply this loss to past or future tax years to reduce their tax liabilities, which can be done via carryback or carryforward procedures.
Key Components
- Carryback: Applying the NOL to prior years, thus obtaining a refund for taxes previously paid.
- Carryforward: Applying the NOL to future years, reducing tax liabilities in those future periods.
- Forms: For carryback claims, businesses may use Form 1040X or 1120X for amended returns, or Form 1045 or 1139 for an application for a tentative refund.
Examples
- Example 1: A company incurs a $50,000 NOL in 2021. The company can carry this loss back to offset taxable income from 2019 and 2020, thus receiving tax refunds or reduce future tax liabilities by carrying it forward to offset income in 2022 and subsequent years.
- Example 2: A self-employed individual has an NOL of $30,000 in 2020. They file Form 1040X to amend their 2018 and 2019 tax returns to apply the NOL, potentially receiving refunds from those years.
Frequently Asked Questions (FAQs)
What is the difference between NOL carryback and carryforward?
- Carryback: Applies the NOL to previous tax years, allowing for a refund of previously paid taxes.
- Carryforward: Applies the NOL to future tax years, reducing taxable income in those years.
Can all types of businesses use NOL deductions?
Most types of businesses, including corporations, sole proprietorships, and partnerships that pass income through to individual partners or owners, can utilize NOL deductions under IRS rules.
How long can NOL be carried forward?
Under the Tax Cuts and Jobs Act (TCJA), NOLs arising after December 31, 2017, can be carried forward indefinitely, though they are limited to 80% of taxable income for each carryover year.
Are there limitations to NOL deductions?
Yes, post-TCJA NOLs are limited to 80% of taxable income starting from 2018, which means you cannot reduce taxable income to zero using only NOL deductions.
What forms are required to claim an NOL deduction?
To claim an NOL carryback, the typical forms are Form 1040X or 1120X (amended returns) or Forms 1045 or 1139 (applications for tentative refunds). For carryforwards, you usually claim the deduction when filing that future tax year’s return.
Related Terms
- Tax Deduction: A reduction of taxable income, which can be achieved via various expenses approved by the IRS.
- Carryforward: The application of a tax attribute or credit from one year to future years.
- Carryback: Retroactive application of a tax attribute or credit to previous tax years, often resulting in a refund.
- Tax Loss: A financial loss reported for tax purposes, which can reduce taxable income.
Online Resources
- IRS Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
- IRS Form 1045: Application for Tentative Refund
- IRS Form 1139: Corporation Application for Tentative Refund
Suggested Books for Further Studies
- “Federal Income Taxation of Corporations and Shareholders” by Boris I. Bittker and James S. Eustice
- “Tax Savvy for Small Business” by Frederick W. Daily
- “Understanding Corporate Taxation” by Leandra Lederman
Fundamentals of Net Operating Loss Deduction: Taxation Basics Quiz
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