On Internal Revenue Service Form 1040X, the abbreviation NOL stands for "net operating loss." A net operating loss occurs when you have certain tax deductions -- usually business- or job-related -- that exceed your entire income. The tax code allows you to shift these losses to other years to reduce your overall tax burden. That's why the abbreviation appears on the 1040X.
Most tax deductions can reduce your taxable income to zero, but no more. For example, if you had $20,000 in income and $30,000 in deductible medical bills, your taxable income would be zero, not minus $10,000. However, under the tax code, certain deductions can actually give you a negative taxable income -- known as a net operating loss, or NOL. In general, the deductions that can produce a net operating loss are business losses, unreimbursed job expenses, casualty and theft losses, job-related moving expenses, and losses on rental property.
Say you had taxable income of $30,000 last year, and you paid the appropriate taxes on that income. Now say you have a net operating loss of $20,000 this year, so you will pay no taxes. Look at the two years put together: You will have a combined total income of just $10,000 ($30,000 minus $20,000) -- and yet you will have paid taxes on $30,000 worth of income. That's not fair. The good news is that the IRS recognizes it isn't fair. That's why people with a net operating loss can use "carrybacks" and "carryforwards."
When you have a net operating loss, you can shift that loss to previous tax years, allowing you to reduce your income in those years and therefore claim a refund for taxes you paid. This shift is called a "carryback," and in general, you can carry back losses for up to two years prior to the year in which you had the NOL. (In certain instances, you can carry losses back for up to five or 10 years.) Any remaining losses can then be carried forward for up to 20 years. So say you had income of $40,000 in each of the past two years, and this year you had an NOL of $100,000. You could carry back $40,000 worth of the NOL for each of the past two years, reducing your income to zero. You could then carry the remaining $20,000 forward until it was used up.
Here's where Form 1040X comes in. Because you would have already filed tax returns for the years prior to your net operating loss, you would have to amend those returns in order to report an NOL carryback and claim a refund. Taxpayers amend a prior year's return by filing Form 1040X. On Line 1 of Form 1040X, you enter your adjusted gross income for the year in question. Take the adjusted gross income from the original return, subtract your NOL carryback, and enter the new amount. There's a box on Line 1 to check if you're claiming a carryback.
- Internal Revenue Service: Publication 536 - Net Operating Losses for Individuals
- IRS: Form 1040X
- TaxSlayer Pro: Net Operating Loss Worksheet/Form 1045
- Loophole Lewy: Items that May Cause a Net Operating Loss
- Internal Revenue Service. "Publication 536 (2019) Net Operating Losses (NOLs) for Individuals, Estates, and Trusts." Accessed Oct. 1, 2020.
- Pennsylvania Institute of Certified Public Accountants. "Net Operating Losses and the TCJA." Accessed Oct. 1, 2020.
- Internal Revenue Service. "Treasury Department and IRS issue guidance for consolidated groups regarding net operating losses." Accessed Oct. 1, 2020.
- New York Times. "Trump's Taxes Show Chronic Losses and Years of Tax Avoidance." Accessed Oct. 1, 2020.
- U.S. Congress. "Worker, Homeownership, and Business Assistance Act of 2009," 123 STAT. 2992 - 2995. Accessed Oct. 1, 2020.
- The Tax Adviser. "Tax Implications of the Five-Year NOL Carryback." Accessed Oct. 1, 2020.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.