Definition
A net operating loss (NOL) occurs when allowable deductions exceed gross income for a tax year. Under section 172, NOLs arising in tax years beginning after December 31, 2017 carry forward indefinitely and generally cannot be carried back, with exceptions for certain farming losses and insurance companies. For years beginning after December 31, 2020, the deduction for these losses is limited to 80 percent of taxable income, computed before the NOL deduction. Older NOLs are used first and are not subject to the 80 percent cap but do expire.
Why it matters in an audit or review
An NOL carryforward is a deferred tax asset, and the valuation allowance depends on whether it is more likely than not to be realized. Auditors tie the schedule to filed returns, separate losses by vintage, and check whether an ownership change under section 382 has limited use.
Example
Illustrative: a corporation has a $500,000 post-2017 NOL and $400,000 of taxable income before the deduction. The deduction is the lesser of $500,000 or 80% x $400,000 = $320,000. Taxable income is $80,000 and $180,000 carries forward. At 25%, the remaining deferred tax asset is $45,000.
Common mistakes
- Applying the 80 percent limit to pre-2018 losses.
- Ignoring state NOL rules, which often differ.
Sources
- Internal Revenue Code section 172: https://www.law.cornell.edu/uscode/text/26/172
- FASB ASC 740-10-30 and 740-10-25, valuation allowance guidance
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error