As a sole proprietor, you may deduct net operating losses in the current year, or save a portion of the losses and carry forward the amount to other years. The IRS generally requires net operating losses to be carried back before they can be carried forward, but this often creates a problem for taxpayers because the years a loss is carried back must be amended to apply the loss before any remaining portions may be carried forward. Losses may carry forward 20 years, or until the net operating loss balance is accounted for, whichever comes first.
Waive the carry back period. Net operating losses are normally required to be carried back three tax years before they can be carried forward. However, you may waive the carry back rules. Attach a statement to the tax return that the net operating loss is generated. You may only do this in the year you generate the initial loss. Your statement must say you are waiving the carry back rule “pursuant to section 301.9100-2.” If you do not attach the statement to your original return, you may amend your return and attach the statement within six months of the original return’s due date.
Calculate your available net operating loss for the year. The first year you carry forward a loss, the carry forward amount is the entire portion. In future years, your net operating loss is determined by subtracting the amount of loss you have used to reduce taxable income to zero in prior years. Add the amounts the losses used in prior years and subtract from your original net operating loss. The result is the amount of loss available.
Calculate the amount to use. Prepare your return until your taxable income is determined. You must use Form 1040 to claim the net operating loss. Your taxable income is shown on line 43.
Claim your net operating loss for the year. You may claim up to the amount of your taxable income, but not more than your taxable income. Report the amount as a negative figure on Form 1040, line 21, Other Income. Write “NOL” on the line to the right of box 21.
Calculate your new carry forward balance. If you do not exhaust all your net operating loss, subtract the amount you deduct on the return from your net operating loss balance. You may carry this new amount forward for use in the next year.