Net Operating Loss
Claim Net Operating Losses for Refunds
As a result of COVID-19 and the unexpected shut down of the national economy, 2020 will likely result in net operating losses for many businesses and individuals through no fault of their own. But what does a net operating loss as defined by the Internal Revenue Service mean for you and your business?
What is a Net Operating Loss?
The Internal Revenue Code defines a Net Operating Loss (NOL) as the deductions allowed minus gross income. One part of the deductions allowed is the taxpayer’s share of the business loss. The net operating loss permits deductions allowed under the tax code to be netted against the business income and nonbusiness income.
Under § 172 of the Code, if the taxpayer has an NOL it can be used as an NOL deduction, which can be carried back or carried forward and used to offset taxable income in the carryback or carryforward year.
An NOL may be present when the taxpayer’s deductions exceed his adjusted gross income and result in a negative taxable income. Typically, an NOL results from losses from a taxpayer’s trade or business.
How a Net Operating Loss Works
Net loss is a product of a business’s expenses exceeding their source of income in the taxable year and is subject to the at-risk and passive activity loss limitations according to the IRS 2019 Instructions for Schedule C.
The net losses from the taxpayer’s business during the taxable year will have to be reported by filing a Schedule C. According to the Internal Revenue Code, when filing taxes for the year an individual or business must determine whether they have taxable income as defined by § 63 of the Code. The Code defines taxable income as gross income minus the deductions allowed.
If a taxpayer has a negative taxable income, the taxpayer may have an NOL as a result of the deductions allowed exceeding the taxpayer’s adjusted gross income. Ultimately, a business’s operating loss is just one part of the taxpayer’s potential NOL.
Limits and Calculating Net Operating Losses
The limits on NOL include capital losses in excess of capital gains and nonbusiness deductions in excess of nonbusiness income among other items.
In calculating an NOL, an individual taxpayer needs to engage in a detailed analysis by distinguishing business deductions from nonbusiness deductions and business income from nonbusiness income.
All of the above information plays a significant role when determining the amount of an NOL and the taxable income of the taxpayer. If you have additional questions about a net operating loss and how it applies to you, contact The May Firm today.