When is a Loss your Gain? When it’s NOL.

If you are starting a new business, you may want to pay attention to your income tax preparation, whether you do it yourself or not. Many new businesses incur losses in their formative years. Unlike personal losses, net business losses are deductible in either prior or future year tax returns.

Another twist to the situation is that many people are not aware that they are considered a business by the IRS. If you receive an IRS Form 1099-MISC with a nonzero entry in Box 7, the IRS considers you a business. Additionally, if there is a nonzero entry in Box 3 of the same form, you may still be considered a business. This article does not pertain to C-Corps. It’s geared towards individuals operating as Sole Proprietors, Partners, or who report their business income on IRS Form 1040, Schedule C. Also, I’ve simplified the discussion because I just want to make you aware of a potential tax benefit. For a more thorough discussion of NOL, refer to the IRS Pub 536.

NOL stands for Net Operating Loss; it occurs when your deductions exceed your income for the year.  In the easy version, after you correctly fill out your tax return using tax software your NOL (if any) appears on Form 1045 Schedule A, Line 25. If the number here is negative, you have an NOL.  Now comes the beneficially interesting part. What do you do with the NOL? An NOL can be used as an above-the-line deduction in prior and future tax years. If you’re unfamiliar with the term above-the-line, basically it’s the best kind of deduction you can have because it reduces your adjusted gross income (AGI). The carryover NOL is entered on IRS Form 1040, Line 21. Generally, you must carry the entire NOL amount to the 2 prior tax years. You start with the earliest tax year. You only use as much NOL as you need to reduce your taxable income to zero. You would have to amend the tax return or file Form 1045 Schedule A to claim the refund, but so what, you're going to get a refund. Your NOL is reduced by the amount you applied. If your still have NOL left, apply it to the next earliest tax year.

If you still have NOL left after going back 2 tax years, you can apply the remaining NOL in the next 20 tax years.  Also, you can carry NOL from multiple tax years. You just have to keep track of where it came from and how much is left.   

The IRS allows you to waive the NOL carryback.  If you choose this option you must notify the IRS with a statement attached to your original return filed by the due date.

So as it turns out, if you operate a business you can “spread out” a loss in one year over multiple profitable years.  This is a pretty good deal and can reduce your taxable income resulting in less tax paid. You just have to be vigilant about keeping track of the NOL and applying it at the right time and place.  Or, have your return prepared by a tax pro like an Enrolled Agent.

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