Posted By Kassandra Cristobal | Posted on: August 22, 2022

by Amanda Domitrowich

Speaking broadly, you may be able to benefit by carrying what is called a “net operating loss” (NOL) into a different year-a year in which you have taxable income-and taking a deduction (the “NOL deduction”) for the loss against that year’s income.

The NOL deduction equals the total of your NOL carryovers and NOL carrybacks to the particular tax year. But, for tax years after 2020, the deduction will be subject to an 80%-of-taxable income limitation.

Your NOLs for tax years 2018, 2019 and 2020 are carried back for five years. But, NOLs for 2021 and later tax years generally can’t be carried back (although farm losses can be carried back two years). And, NOLs for tax years after 2017 are generally carried forward indefinitely.

You must carry the NOL first to the earliest year allowed, and, then, successively, to the next earliest year, etc. until the loss is used up. But, if it would benefit you more to just carry a NOL forward, you can waive carryback of that loss.

To determine the amount of your NOL for a particular tax year, you don’t just use the negative taxable income reported on your tax return for that year. Instead, several modifications must be made to compute the amount of your NOL. These include the following:

• (1) You cannot use your personal or dependency exemptions-for the years in which these are available (i.e., after 2025 and before 2018).
• (2) You cannot use any NOL from a different year.
• (3) “Nonbusiness” capital losses (those arising outside of your trade or business, or your employment) can only be used against “nonbusiness” capital gains. Excess capital losses cannot increase your NOL.
• (4) “Nonbusiness” deductions (e.g., charitable donations, deductible medical expenses, mortgage interest, alimony, etc.) can only be used against “nonbusiness” income (interest, dividends, etc.). That is, they cannot directly increase your NOL. However, if you have nonbusiness capital gains in excess of nonbusiness capital losses (see (3), above), you can use your “excess” nonbusiness deductions against these gains. (Note that casualty losses are treated as fully usable “business deductions” for these purposes.)
• (5) Finally, “business” capital losses can only be used against “business” capital gains, except that if you still have nonbusiness capital gains after netting nonbusiness capital losses and excess nonbusiness deductions against them, you can use your business capital losses against them.

Example. N has a loss of $20,000 from business operations for the year. N also has (i) nonbusiness capital gains of $9,000 and nonbusiness capital losses of $4,000, and (ii) nonbusiness income of $13,000 and nonbusiness deductions of $14,000 (not including personal or dependency exemptions). N has no business capital gains or losses.

N’s “starting point” for calculating N’s NOL is N’s $20,000 business loss. N’s capital losses reduce N’s capital gains to $5,000 ($9,000 − $4,000). N’s nonbusiness deductions wipe out N’s nonbusiness income ($13,000 − $14,000), leaving N with $1,000 “excess” nonbusiness deductions. N can use the $1,000 excess nonbusiness deductions to further reduce N’s capital gains to $4,000. But, the $4,000 of capital gains do reduce N’s NOL from $20,000 to $16,000. The final result: N incurs a $16,000 NOL for the tax year.

Note that N’s taxable income will show a loss that’s greater than N’s $16,000 NOL, because N’s taxable income includes items such as personal exemption that aren’t allowed in figuring N’s NOL. Only the $16,000 NOL, however, can be carried forward to other years for use as a deduction.

The above computations can grow quite complex, depending upon your circumstances.

In addition to the rules above, special rules allow farmers to retain a pre-2018, two-year NOL carryback election and then applicable 80%-of-taxable-income limitation, for farming losses arising in 2018, 2019 or 2020 tax years, and to revoke a previously made waiver of the two-year carryback for 2018 or 2019 farming losses, and apply the five-year carryback instead. Obviously, there’s a lot to consider in determining the amount of your NOL, and whether to claim an NOL deduction. Please contact us today and we will be happy to discuss further.