A net operating loss, or NOL, is what you have when your allowable business deductions for the year exceed your gross income. Under Section 172 of the Internal Revenue Code, that shortfall can be carried forward to reduce taxable income in a future profitable year, though for losses arising after 2017 the deduction is generally capped at 80% of that year’s taxable income.1Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction How the rules apply to you depends on your business structure, when the loss originated, and whether your state follows the federal framework.
How the Loss Amount Is Calculated
Start with total deductions minus gross income. If deductions win, you have a raw loss. For individual taxpayers, two adjustments then bring that number down to a true NOL:
- Capital losses count only up to the amount of capital gains. Net capital losses cannot pad an NOL.
- Non-business deductions, including the standard deduction and personal investment expenses, can offset only non-business income, not business income.
Both adjustments keep personal financial activity from inflating a business operating loss.1Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction Corporations skip these two restrictions; they apply only to individual filers.
The 80% Deduction Cap
When you carry an NOL forward, it will not usually erase your entire tax bill. For any NOL from a tax year beginning after December 31, 2017, the deduction cannot exceed 80% of taxable income for the year you apply it, calculated before the NOL deduction itself, any Section 199A qualified business income deduction, or any Section 250 deduction.2Internal Revenue Service. Instructions for Form 172 (Rev. December 2024) At least 20% of that year’s taxable income stays on the tax bill no matter how big the carryforward is.
Older NOLs from years before 2018 escape the cap and can offset taxable income dollar for dollar. If you have carryforwards from more than one year, pre-2018 losses are used first without a percentage limit, and post-2017 losses come next subject to the 80% rule.2Internal Revenue Service. Instructions for Form 172 (Rev. December 2024) Multiple post-2017 losses are generally absorbed in the order they arose.
A Simple Example
Your business generates a $200,000 NOL in 2024. In 2026 you earn $150,000 in taxable income. The 80% cap lets you deduct up to $120,000 against that income. The remaining $80,000 of unused NOL carries into 2027 and beyond.
Carryforward and the Farming Carryback
Post-2017 NOLs can be carried forward indefinitely until they are fully used.3Internal Revenue Service. Instructions for Form 172 (12/2024) For most taxpayers, carrying a loss back to a prior year to claim a refund is no longer an option.
Farming businesses keep a narrower version of that option. If your NOL includes a farming loss, meaning the portion of the loss attributable to a farming operation, you can carry that portion back two years and claim a refund of taxes previously paid.1Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction You can also elect to skip the carryback and carry the farming loss forward instead. The election is due with your return for the loss year (including extensions) and is irrevocable once made.
The Excess Business Loss Hurdle for Individuals
Individual taxpayers face a separate limit that applies before an NOL is even calculated. Under Section 461(l), for 2026 the portion of your total net business losses that exceeds $256,000 ($512,000 on a joint return) is disallowed as a current-year deduction. The thresholds are adjusted annually for inflation.4Internal Revenue Service. Revenue Procedure 2025-32
The disallowed amount is not lost. It converts into an NOL carryforward available in future years, subject to the standard 80% limit.5Internal Revenue Service. 2025 Instructions for Form 461 – Limitation on Business Losses Track each year’s excess business loss separately on Form 461. The limitation applies to individuals, trusts, estates, and pass-through owners; C-corporations are outside it.
How the Loss Flows Through Different Entities
Where the NOL shows up depends on how your business is organized.
- C-corporations claim the NOL directly on Form 1120. The loss reduces the corporation’s own taxable income in later years.
- Sole proprietors and single-member LLCs report business income and loss on Schedule C of Form 1040. A net loss there can contribute to an NOL on the individual return.6Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
- S-corporations and partnerships do not pay income tax or claim NOLs at the entity level. Each owner’s share of income or loss is reported on Schedule K-1, and the owner uses that on a personal return.7Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065) (2025)
For pass-through owners, the deductible loss is further limited by your basis in the entity, the at-risk rules, and the passive activity rules. All three tests must be met before a loss reaches your personal return.
Which Forms You Need
Individuals, estates, and trusts calculate the NOL amount on Form 172.3Internal Revenue Service. Instructions for Form 172 (12/2024) Sole proprietors begin on Schedule C, where line 31 shows the net profit or loss and feeds the NOL calculation once the at-risk and passive activity rules have done their work.8Internal Revenue Service. Instructions for Schedule C (Form 1040) (2025) Corporations report income and deductions on Form 1120, using line 28 as the starting point for determining whether an NOL exists for the year.9Internal Revenue Service. 2025 Instructions for Form 1120 – U.S. Corporation Income Tax Return
If you qualify for a carryback (primarily farming losses), request a quick refund on Form 1045 for individuals or Form 1139 for corporations. Both must be filed within 12 months after the end of the loss year, and the IRS processes these tentative refund applications within 90 days of the later of the filing date or the return due date.10Internal Revenue Service. Instructions for Form 1045 (2025)11Internal Revenue Service. Instructions for Form 1139 (Rev. December 2025) The slower path is an amended return: Form 1040-X for individuals or Form 1120-X for corporations, with IRS processing typically running 8 to 12 weeks and sometimes as long as 16.12Internal Revenue Service. Amended Returns and Form 1040X
Records to Keep While a Carryforward Is Alive
Because NOLs can be carried forward indefinitely, records need to outlive the loss. The IRS generally requires tax records for at least three years from the filing date, seven years for claims involving bad debts or worthless securities, and four years for employment tax records.13Internal Revenue Service. How Long Should I Keep Records? Records for business property should be kept until the statute of limitations closes for the year the property is disposed of, so you can compute depreciation and any gain or loss on sale.14Internal Revenue Service. Topic No. 305, Recordkeeping While a carryforward is still in play, keep the original loss-year return, the Form 172 calculation, and the receipts behind it for as long as any part of the loss remains unused.
State Rules Are Not the Federal Rules
Do not assume your state mirrors the federal NOL treatment. Most states that impose a corporate income tax allow some carryforward, but the window is often 5 to 20 years rather than indefinite. Some states cap the annual deduction in dollars, and a handful that use gross receipts taxes instead of income taxes offer no NOL deduction at all. Carrybacks have been eliminated in most states, though a few still permit up to three years. Check your state tax agency’s guidance before applying a federal NOL to a state return; the allowed amount and the timing can be different.