Many business owners report a net loss each fiscal year. To encourage taxpayers to start new businesses, the Internal Revenue Service allows entrepreneurs to deduct a portion of their business losses on their income tax returns. These tax filers can use the amount of their business loss to offset other income for past or future years. To claim a business loss, taxpayers must follow certain IRS guidelines.
Net Operating Losses
Business owners have a net operating loss when the amount of their business expenses for the year exceeds the amount of income they generated. While a net operating loss is generally considered to apply to businesses, the term is also used when a taxpayer’s employee expenses exceed his earned income from an employer or when a rental property owner pays more in expenses than he receives in rental income.
Figuring a Net Operating Loss
A taxpayer is entitled to deduct a net operating loss on her tax return. As an example, a business owner who has a $2,000 business loss in 2010 may be able to deduct the full amount. Before the qualifying net operating loss can be determined, however, the taxpayer must calculate all other deductions from taxable income such as exemptions, standard or itemized deductions, and capital losses. These amounts are not included as part of the net operating loss.
Net Operating Loss Carryover Time Limit
Net operating losses are not eligible for a deduction in the year they occur. However, taxpayers can choose to carry the losses back two years or forward 20 years or they can make use of both options by carrying the loss back and then forward until it is used up. Net losses from certain occupations may qualify for a longer carryback period. Taxpayers can also decide to waive the carryback period and only carry their net operating losses forward for 20 years or until they exhaust the entire loss. The amount that can be deducted each year is limited to the loss in excess of the taxpayer’s modified adjusted gross income for each future tax year.
Net Operating Loss Carryover Recordkeeping
The Internal Revenue Service recommends that taxpayers keep the documents that support their tax deductions for at least three years after the return is filed. This especially applies to net operating losses, since they can be carried forward for several years. Taxpayers who claim a net operating loss should keep their supporting documentation for at least three years after the carryover period runs out.
- IRS: Publication 536 - Net Operating Losses (NOLs) for Individuals, Estates and Trusts
- IRS: Disaster Assistance Self-Study - Reporting Casualty Gains and Losses
- IRS: Passive Activity Loss ATG - Chapter 2, Rental Losses
- IRS: Publication 17 (2010) - Your Federal Income Tax
- Internal Revenue Service. "About Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts." Accessed Feb. 10, 2020.
- Internal Revenue Service. "2019 Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts," Page 2. Accessed Feb. 10, 2020.
- Internal Revenue Service. "2019 Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts," Pages 4-5. Accessed Feb. 10, 2020.
Selena Robinson has been writing professionally since 2009, specializing in areas such as music, business and education. Robinson received an accounting diploma from Ogeechee Technical College in 2001 and worked as a tax accountant for several years before becoming a writer. Her areas of expertise include payroll taxes, small-business taxes, general accounting, personal finance and individual income tax returns.