Net Operating Losses: The 80 Percent Limit, Carryforwards and Section 382

A net operating loss (NOL) is a tax loss that can be used against taxable income in other years. For an audit team the NOL shows up as a deferred tax asset on the balance sheet, a valuation allowance judgment, and sometimes a due diligence question after a change in ownership. Two statutes drive the answers. Section 172 of the Internal Revenue Code governs how much loss can be used and for how long. Section 382 limits what a loss corporation can use after its ownership changes.

This page paraphrases the statutes. Read IRC sections 172 and 382 and the related regulations for the full rules, and have a tax professional apply them to a specific taxpayer. State rules differ and are outside this page.

How does section 172 work after 2017?

The Tax Cuts and Jobs Act changed NOL treatment for losses arising in tax years beginning after December 31, 2017, and the CARES Act adjusted it for a few years. The current structure in the statute has three layers.

The 80% limit is spelled out in section 172(a)(2) for taxable years beginning after December 31, 2020. The deduction equals the pre-2018 NOLs carried to the year, plus the lesser of the post-2017 NOLs carried to the year or 80% of the excess of taxable income, computed without regard to the NOL deduction and the section 199A and 250 deductions, over the pre-2018 NOL amount. Pre-2018 losses therefore come first and sit outside the 80% cap.

Exceptions to the no-carryback rule exist. Farming losses carry back 2 years. Insurance companies other than life insurance companies carry back 2 years and forward 20.

A worked illustration

Illustrative numbers only. A corporation has taxable income of $400,000 for 2026 before any NOL deduction, section 199A or section 250 deduction. It holds a pre-2018 NOL of $100,000 and a post-2017 NOL of $500,000.

If the corporation held only the post-2017 NOL, the deduction would be the lesser of $500,000 or 80% x $400,000 = $320,000, leaving $80,000 of taxable income and $180,000 of NOL to carry forward. A corporation with an NOL still pays tax in a profitable year.

What is section 382?

Section 382 applies when a loss corporation undergoes an ownership change. An ownership change occurs when, immediately after an owner shift involving a 5-percent shareholder or an equity structure shift, the percentage of stock owned by one or more 5-percent shareholders has increased by more than 50 percentage points over the lowest percentage they owned at any time during the testing period. The testing period is generally the 3-year period ending on the day of the owner shift or equity structure shift, and it is shorter in some cases, for example after a prior ownership change.

After an ownership change, the amount of taxable income of the new loss corporation that can be offset by pre-change losses in a post-change year is limited to the section 382 limitation. In general that limit is:

value of the old loss corporation x the long-term tax-exempt rate

The value is generally the value of the stock of the corporation immediately before the ownership change, adjusted for redemptions or other corporate contractions that occur in connection with the change. The long-term tax-exempt rate is published by the IRS each month. If the limitation exceeds the taxable income actually offset in a year, the unused amount adds to the limitation for the next year.

Two further rules matter. The limitation drops to zero if the new loss corporation does not continue the old loss corporation's business enterprise at all times during the 2-year period beginning on the change date. And the limitation can increase for recognized built-in gains when the old loss corporation had a net unrealized built-in gain on the change date.

Illustration with a hypothetical rate: a loss corporation is worth $5,000,000 immediately before an ownership change, and the long-term tax-exempt rate for the month is 3.5%. The annual limit is $5,000,000 x 3.5% = $175,000. Against $2,000,000 of pre-change NOLs, at $175,000 a year it would take more than 11 years to use them ($2,000,000 / $175,000 = 11.4), subject to the carryforward of any unused limitation and to any built-in gain increase. Use the actual published rate for the month of the change when computing a real limit.

How does this affect the financial statements?

ASC 740 recognizes a deferred tax asset for NOL carryforwards, then reduces it by a valuation allowance if it is more likely than not that some or all will not be realized. See deferred tax assets and liabilities and valuation allowance.

Practice observations built from how the rules work, not requirements of the statutes:

• Indefinite carryforward changes the scheduling. Post-2017 NOLs do not expire, so they can generally be treated as available to offset the reversal of taxable temporary differences that also reverse indefinitely, but only up to the 80% limit.
• Vintage tracking matters. A schedule that separates pre-2018 and post-2017 NOLs is needed, because only the second is capped at 80% and only the first expires. The deferred tax rollforward is the place to keep it.
• Section 382 limits the asset's value. If an ownership change occurred, the portion of the NOL that cannot be used because of the limitation, or because it would expire before it can be used, does not support a deferred tax asset.
• Ownership changes are not always obvious. Equity raises, option exercises, a buyout of a minority owner and secondary trading can combine to cross 50 percentage points. Ask for the equity roll and any prior section 382 study.
• Interest limitation interaction. The NOL deduction is excluded when computing adjusted taxable income under section 163(j).
• State conformity. State NOL carryforward periods and limits differ from the federal rules, so state deferred tax assets need their own schedule.

Frequently asked questions

Can a company still carry back an NOL?

For losses arising in tax years beginning after December 31, 2020, generally no. Farming losses and certain insurance company losses are the statutory exceptions.

Does the 80% limit apply to every NOL?

It applies to net operating losses arising in tax years beginning after December 31, 2017, when they are deducted in taxable years beginning after December 31, 2020. Losses from before 2018 are deducted first and are not capped at 80%.

What triggers section 382?

An ownership change, defined as an increase of more than 50 percentage points in stock ownership by 5-percent shareholders over the lowest percentage they held during the testing period, generally three years.

Does an NOL expire?

NOLs arising in tax years beginning before 2018 expire after 20 years. NOLs arising in tax years beginning after 2017 carry forward indefinitely.

Sources

• IRC section 172 (net operating loss deduction) and section 382 (limitation on net operating loss carryforwards), including subsections (a), (b), (c), (e), (g), (h) and (i): Cornell LII, 26 U.S.C. 172 and 26 U.S.C. 382
• IRS, Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts (for individual taxpayers)

Related

• ASC 740 income taxes for private companies
• Section 163(j) business interest limitation
• Deferred tax rollforward and valuation allowance template
• Going concern assessment
• Business combinations under ASC 805
• Uncertain tax positions under ASC 740-10

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error