Definition
Net Operating Loss (NOL) refers to the situation where a taxpayer’s allowable deductions exceed their gross income within a tax year. Specific adjustments prescribed by the Internal Revenue Code (IRC) aim to restrict NOL deductions primarily to business losses. Corporations that incur an NOL do not pay taxes for the year in which the loss occurs. These corporations can claim a tax refund for the taxes paid during the prior two years and can carry forward the NOL to offset taxable income for up to 20 future years.
Examples
- Corporation A: In the tax year 2022, Corporation A’s business experienced significant operational costs due to an economic downturn, leading to allowable deductions of $1.5 million against a gross income of $1 million, resulting in an NOL of $500,000.
- Individual Case: An individual running a small business has gross income of $80,000 and allowable business deductions of $100,000, resulting in an NOL of $20,000 for the tax year.
Frequently Asked Questions (FAQs)
What is the purpose of NOL?
NOL allows businesses and individuals to reduce taxable income by carrying forward losses from unprofitable years to future profitable years, thereby spreading the tax benefit over several periods.
How long can NOL be carried forward or carried back?
Under the rules before the Tax Cuts and Jobs Act (TCJA) of 2017, NOLs could be carried back two years and carried forward 20 years. Post-TCJA, NOLs can generally only be carried forward indefinitely but are limited to 80% of taxable income.
Can individuals claim NOL?
Yes, individuals can claim NOL, but it is generally restricted to business losses, including losses from the operation of a trade, business, casualty, or theft losses.
What is the impact of NOL on tax returns?
NOL can reduce taxable income in future years, providing significant tax relief by lowering the amount of tax owed in years where the business is profitable.
Related Terms
- Deductions: Expenses subtracted from gross income to determine taxable income.
- Gross Income: The total income before any deductions or exemptions.
- Internal Revenue Code (IRC): The federal tax law enacted by the IRS.
- Carryback: Applying a net operating loss to a prior year’s tax return to receive a refund for taxes previously paid.
- Carryforward: Applying a net operating loss to future years’ tax returns to reduce future taxable income.
Online References
- IRS: Net Operating Losses (NOL) and How To Deduct Them
- Investopedia: Net Operating Loss (NOL) Definition
Suggested Books for Further Studies
- “Taxation of Individuals and Business Entities” by Brian Spilker et al.
- “Federal Income Taxation” by Joseph Bankman, Thomas D. Griffith, and Katherine Pratt.
- “Principles of Corporate Taxation” by Douglas A. Kahn, Jeffrey Kahn.
Fundamentals of Net Operating Loss (NOL): Taxation Basics Quiz
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