NOL Tax Deduction Rules: Carryforwards, 80% Cap, and Section 382

The net operating loss deduction lets you use a year’s business loss to reduce taxable income in another year. Under current federal net operating loss deduction rules, a loss arising in a tax year that began after December 31, 2017 carries forward indefinitely, offsets up to 80% of the future year’s taxable income, and generally cannot be carried back. How you calculate the loss, what other limits apply first, and how you track the balance year to year all determine whether the deduction survives an audit.

What Counts as a Net Operating Loss

An NOL is the excess of your allowable deductions over your gross income for the year, but only after a specific set of statutory modifications.¹ Those modifications exist to keep the loss tied to genuine business shortfalls rather than personal deductions or paper losses from capital transactions.

For individual taxpayers, the key adjustments are:

Non-business deductions, such as IRA contributions, the standard deduction, and most itemized deductions, can only offset non-business income. Any excess does not count toward the NOL.¹
Non-business capital losses can only offset non-business capital gains. Business capital losses offset business capital gains plus any leftover non-business capital gains, and capital losses can never exceed capital gains in the NOL computation.¹
No deduction for personal exemptions is allowed in computing the NOL. Personal exemptions return in 2026 at pre-TCJA levels adjusted for inflation, so they must be added back when figuring an NOL for 2026 and later years.²
You cannot use a prior-year NOL deduction or the Section 199A qualified business income deduction when computing the current year’s NOL.¹

C corporations have a simpler computation because the non-business deduction and capital loss modifications only apply to individuals. A corporation’s NOL is essentially its negative taxable income for the year before any NOL deduction or dividends-received deduction adjustments.

Substantiation matters. If the IRS audits the deduction, you have to prove the numbers with receipts, payroll records, and invoices. Failing to substantiate can lead to full disallowance plus an accuracy-related penalty of 20% of the resulting underpayment.³

The 80% Taxable Income Cap

You cannot erase your entire taxable income with an NOL deduction. For losses arising in tax years beginning after December 31, 2017, the deduction is capped at 80% of taxable income figured without the NOL deduction itself, the Section 199A deduction, or the Section 250 deduction.¹ The remaining 20% is taxed at normal rates no matter how large your accumulated loss.

An example: a $500,000 loss from a prior year meets $100,000 of income this year. You can offset $80,000. Tax is owed on the other $20,000. The unused $420,000 carries into next year.⁴

Pre-2018 losses are not subject to the 80% cap. If you still hold both pre-2018 and post-2017 losses, the older losses apply first against taxable income without a percentage limit, and the 80% cap applies only to the newer losses against whatever income remains.¹

A common and expensive mistake is ignoring the cap when making estimated tax payments. Assuming zero tax owed because accumulated losses exceed current income can produce underpayment penalties and daily-compounding interest on what should have been paid in.

Carryforward and Carryback

A post-2017 loss carries forward indefinitely. There is no expiration date, so an NOL generated today remains available until you have enough income to absorb it.⁴

The trade-off is that carrybacks are gone for most taxpayers. You generally cannot carry a post-2017 loss back to a prior year to claim a refund of tax already paid.⁴ The loss sits as a future asset rather than generating immediate cash.

Farming Loss Exception

Farming businesses are the main exception. A farming loss can be carried back two years, giving farmers quicker access to cash during bad seasons.⁵ Certain insurance companies also retain limited carryback rights.

Farmers who prefer not to carry back can waive the carryback by attaching an election statement to the original return for the loss year. The election is generally irrevocable. To carry back, use Form 1045 (individuals) or Form 1139 (corporations) for faster processing, or file an amended return for the carryback year.

Tracking the Balance

Because losses carry forward indefinitely, you need a system that tracks the remaining balance year after year. Each use reduces the carryforward by that amount. Losing track can mean overstating the deduction, which triggers penalties, or understating it, which means paying more tax than owed. Attach an NOL schedule to your return each year showing the original loss, prior usage, and remaining balance.

Excess Business Loss Limitation

Before the NOL rules even engage, Section 461(l) limits how much business loss a non-corporate taxpayer can claim in a single year. For 2025, business losses can exceed business income by no more than $313,000 for single filers and $626,000 for joint filers, with annual inflation adjustments.⁶

Any excess above the threshold is disallowed for the current year and converted into an NOL carryforward for future years.⁷ The rule applies after at-risk and passive activity limits, acting as a final cap on business losses flowing to your return. Taxpayers report the computation on Form 461.

Consider a sole proprietor who loses $800,000 in one year while filing jointly. Only $626,000 (using the 2025 threshold) offsets other income such as wages or investment earnings, and the remaining $174,000 becomes an NOL carryforward subject to the 80% cap in future years.

Losses From S Corporations and Partnerships

If you own an S corporation or partnership interest, losses that pass through to your personal return must clear four hurdles in order before you can deduct them:⁸

Stock and debt basis. You can only deduct losses up to your basis in the entity’s stock plus any debt the entity owes you personally. Shareholders track basis themselves; the company does not.
At-risk limitation. Even with enough basis, deductions are capped at the amount you could actually lose.
Passive activity loss limitation. If you do not materially participate, losses are passive and can generally only offset passive income.
Excess business loss limitation. The Section 461(l) threshold acts as the final filter.

Losses blocked by the basis test are suspended and carry forward indefinitely, becoming deductible when basis rises through additional capital contributions or loans to the entity.⁸ If you sell or otherwise dispose of all your stock while losses remain suspended, those losses are permanently forfeited. Shareholders who neglect basis tracking fall into this trap regularly.

Ownership Changes and Section 382

When a corporation with accumulated NOLs undergoes a significant change in ownership, Section 382 sharply limits how much of those losses can be used each year going forward. An ownership change occurs when one or more 5-percent shareholders increase their combined stake by more than 50 percentage points over a three-year testing period.⁹ It can happen through a single acquisition or gradually through multiple stock transactions.

Once triggered, the annual amount of pre-change losses usable equals the value of the company immediately before the change multiplied by the IRS long-term tax-exempt rate.⁹ As of mid-2026, that rate is 3.68%.¹⁰ A company valued at $10 million before the ownership change could use roughly $368,000 of its pre-change NOLs per year regardless of subsequent profitability.

Section 382 exists to prevent companies from being acquired primarily for their tax losses. Buyers routinely discount the value of a target’s NOLs based on this annual cap. If you are selling a business with meaningful NOLs or acquiring one, run the Section 382 analysis before the deal closes, not after.

Reporting the Deduction

Individuals report the NOL deduction on Schedule 1 of Form 1040, which flows into the main return. Starting with the 2025 tax year (returns filed in 2026), the IRS introduced Schedule 1-A for certain additional deductions, so check the current year’s form instructions to confirm which line applies.¹¹

For a farming loss carryback, Form 1045 lets individuals, estates, and trusts apply for a tentative refund faster than an amended return. Corporations use Form 1139. Form 1045 must be filed within one year after the end of the loss year. The IRS processes the application within 90 days of the later of your filing date or the due date (with extensions) of the loss-year return.¹²

E-filed returns claiming only a carryforward deduction generally process within 21 days.¹³ Complex or flagged returns take longer, so attach every supporting schedule. If the NOL calculation still leaves tax owed and you do not pay on time, the failure-to-pay penalty accrues at 0.5% per month up to 25% of the unpaid amount.¹⁴

State Rules Differ

Your state may not follow the federal NOL rules. Many states decouple from the indefinite carryforward, capping it at 20 years or another fixed period. Some do not adopt the 80% taxable income limitation, applying either a stricter cap or none. A few have temporarily suspended NOL deductions entirely during revenue shortfalls.

Assuming state and federal treatment are identical is a fast way to overstate or understate the state deduction. If your business operates in more than one state, each state’s rules apply independently to the income apportioned to that state. Review state conformity every year, because legislatures change these provisions often.

1
Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction
2
Congress.gov. Expiring Provisions in the Tax Cuts and Jobs Act
3
Internal Revenue Service. Accuracy-Related Penalty
4
Internal Revenue Service. FAQs – Carryback of NOLs by Certain Exempt Organizations
5
Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction
6
Internal Revenue Service. Instructions for Form 461 – Limitation on Business Losses
7
Internal Revenue Service. Excess Business Losses
8
Internal Revenue Service. S Corporation Stock and Debt Basis
9
Office of the Law Revision Counsel. 26 U.S. Code 382 – Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change
10
Internal Revenue Service. Revenue Ruling 2026-11
11
Internal Revenue Service. Schedule 1-A, Additional Deductions – What to Know About the New Form
12
Internal Revenue Service. Instructions for Form 1045 – Application for Tentative Refund
13
Internal Revenue Service. Processing Status for Tax Forms
14
Internal Revenue Service. Failure to Pay Penalty