This article explains how to qualify for a tax loss carryforward and how the process works for a small business owner.
What Is a Tax Loss?
A tax loss, otherwise known as a net operating loss (NOL), is the opposite of a profit (net income). A business has NOL when expense deductions are greater than income. The word “operating” is key because these losses must come from the business’s regular operations. All types of business owners, except shareholders (owners) of corporations, may claim their share of NOL on their personal tax returns.
Limits on Business Tax Losses
Most small business owners can take the full amount of their business losses to offset other income because they participate in their business and take risks to do so. But a business owner’s NOL for a year may be limited depending on the situation. Some owners don’t participate in their business and don’t assume any risks. This type of owner might be a limited partner who invests in the partnership but doesn’t participate in managing the business. It might also be an owner of rental property, who is considered a passive investor even if they participate in managing the property. This second type of business owner might have their business losses limited to the amount at risk in the business. In calculating NOL, you must remove other items that limit your loss, including:
Capital losses in excess of capital gains Nonbusiness deductions in excess of nonbusiness income The NOL deduction itself Qualified business income deductions
What Is a Tax Loss Carryforward?
A tax loss carryforward moves a tax loss freom one year to a future year of profit. Beginning in 2018, the NOL carryover amount is limited to 80% of the excess of taxable income (determined without regard to the deduction). These losses may be carried forward indefinitely.
Who Can Use a Tax Loss Carryforward?
Small business owners and other individuals may use a tax loss carryforward for several different purposes. The most common reason for using this tax provision is to offset income for the year with business losses to reduce taxable income. Sole proprietors, limited liability company members (owners), partners in partnerships, and S corporation owners can use these rules on their share of business income. Corporations can use loss carryback rules against a net operating loss. The corporation can take different deductions and it must make some changes to its taxable income to figure the NOL. It also uses different forms to report net operating losses on its tax return.
How to Claim a Tax Loss Carry Forward
Here’s the general process for determining whether you can take a tax loss carryforward for a tax year. Use IRS Form 1045 Schedule B to calculate the NOL carryover and include it on your personal tax return.
Example of How a Tax Loss Carryforward Works
A business owner has net operating loss of $100,00 in Year 1 and decides to take this loss over four years.
Get Help With Loss Carryforward Calculations
There are many rules and exceptions for claiming a tax loss carryforward and the calculations are complicated. Get the help of a licensed tax professional for this process. IRS Publication 536 has more details on how to calculate NOL, how to apply the loss to your tax return, and how to carry it forward to future years.
How long can tax losses be carried forward?
Both state and federal tax laws allow tax losses to be carried forward for an indefinite number of years. You can only carry over 80% of the loss from each year. If you have more than one net operating loss (NOL) for the year from several years of losses, apply the NOLs against your modified taxable income, starting with the most recent year.
Which tax form does my loss carryforward go on?
As a small business owner, you pay tax on business income and other income on your personal tax return, Form 1040, or 1040-SR (for seniors). If you are filing business taxes as a sole proprietor, for example, you report your business income on Schedule C and include this with other income and deductions to get your adjusted gross income for the year. Partners in partnerships and S corporation owners can take a loss carryforward based on their share of business income for the year. They report this income each year by including a Schedule K-1 with their tax return. If you are reporting a tax loss carryforward for a year, use IRS Form 1045, Schedule B to calculate the loss, then add it to your tax return.
Is there a maximum loss carryforward?
The maximum loss you can carry forward for a year is 80% of taxable income, modified by removing some deductions. You may have NOL for the year if your adjusted gross income on your tax return is less than your deductions (the standard deduction or itemized deductions). You will need to calculate the NOL by subtracting some of the deductions and losses to figure out the amount you can carry forward to future years. Then you will need to
