Net Operating Loss Carryforward for Individuals

What counts as an NOL

An NOL arises when allowable deductions in a year exceed income, usually because of a trade or business, such as a Schedule C loss. It is not the same as negative taxable income on the return. Form 172 adjusts the figure, and some items are limited or excluded: for example, capital losses and nonbusiness deductions are restricted in the calculation, so the NOL can be smaller than the loss the return appears to show.

Sole proprietors, single-member LLC owners who report on Schedule C, and traders with an ordinary loss from a section 475(f) mark-to-market election can all have business losses. Wages count as business income in this computation, and personal deductions such as the standard deduction can only offset nonbusiness income, so they cannot create an NOL on their own. The NOL deduction reduces income tax. It does not reduce self-employment tax.

Carryforward and carryback rules by year

The rules depend on the tax year in which the loss arose. Congress changed them in 2017 and again in 2020.

When you hold both older and newer NOLs, pre-2018 amounts are used first. The 80% limit is then figured on the taxable income that remains after the pre-2018 deduction.

Excess business losses under section 461(l)

Before an NOL is computed, a separate rule can cap how much business loss an individual deducts in a year. Under section 461(l), business losses above an inflation-adjusted threshold are treated as an excess business loss and are not allowed for that year. The disallowed amount is treated as an NOL carryforward to the following year, where the 80% limit can then apply.

The threshold changes with inflation, and Congress has amended the rule more than once, including suspending it for 2018 through 2020, so check the current Form 461 instructions for the year you are filing. Basis, at-risk and passive activity rules apply before the excess business loss test and can limit a loss on their own.

Capital losses are a different track

Capital losses are not NOLs. Net capital losses offset capital gains, and a net loss beyond that can reduce ordinary income by up to $3,000 a year ($1,500 if married filing separately). The unused portion carries forward indefinitely and keeps its short-term or long-term character.

Because the rules are separate, one year can produce both a capital loss carryover and an NOL. They are tracked on different forms: the Capital Loss Carryover Worksheet in the Schedule D instructions for capital losses, and Form 172 for the NOL.

Records to keep

An NOL can be used many years after it arose, and the rules depend on the year of origin, so the paper trail matters.

• The Form 172 computation for the year the loss arose (or the Publication 536 worksheet used for loss years before Form 172 existed), including what was excluded or limited.
• Each later return that used part of the NOL, and the amount used.
• The year each NOL arose, kept as a separate balance, since pre-2018 and later losses follow different limits.
• Any capital loss carryover worksheet, kept apart from the NOL record.

On the return, the NOL deduction appears as a negative amount on Schedule 1 (Form 1040). A preparer can confirm the treatment of any special case, such as a loss that was carried back before 2021.

How to do this in BudgetR

1. Open the Tax workspace and choose the tax year you are working on.
2. In the loss ledger, enter each NOL carried in from earlier years as its own lot, with its origin year and amount. Enter capital loss carryovers separately, from the prior return's carryover worksheet.
3. Review the year's preview: the opening balance, the NOL used and the closing balance. BudgetR models pre-2018 lots first and applies the 80% limit to later lots.
4. When the year produces a new NOL, BudgetR calculates it with Form 172 logic. Record it as a lot only after the year's diagnostics are resolved.
5. Export the result as JSON or CSV to share with your tax preparer. BudgetR Tax estimates and organizes; it does not file returns.

Key takeaways

• An NOL from a tax year beginning after 2020 carries forward indefinitely and generally cannot be carried back; farming losses have a two-year carryback.
• For NOLs arising after 2017, the deduction is limited to 80% of taxable income figured without the NOL and QBI deductions, and unused NOL carries forward again.
• Pre-2018 NOLs are not subject to the 80% limit and are used before later NOLs.
• A disallowed excess business loss under section 461(l) becomes an NOL carryforward; check the current Form 461 instructions.
• Capital losses follow separate rules ($3,000 ordinary income limit, then carryover) and are not NOLs.
• Keep Form 172 workpapers and prior returns, and confirm the details with a tax professional.

Sources

• Instructions for Form 172, Net Operating Losses (IRS)
• About Form 172, Net Operating Losses (IRS)
• Instructions for Form 461, Limitation on Business Losses (IRS)
• Instructions for Schedule D, Capital Gains and Losses (IRS)

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• Trading Journal Returns: Separate Performance From Deposits
• Annual Budget Planner: Plan Your Year Month by Month