Net Operating Loss (NOL)
A net operating loss (NOL) occurs when a business's tax-deductible expenses exceed its taxable income in a given year, and the resulting loss can be carried forward to offset future taxable income.
A net operating loss happens when your allowable business deductions exceed your gross income for the year. Rather than losing this tax benefit, the IRS allows you to carry the loss forward to reduce taxable income in future profitable years.
Under current rules (post-2017 TCJA), NOLs can be carried forward indefinitely but can only offset up to 80% of taxable income in any given year. The previous option to carry losses back to prior years was eliminated for most taxpayers (with exceptions for farming losses).
NOLs are common in the early years of a business, during major expansion phases, or when large depreciation deductions (such as from cost segregation or bonus depreciation) create paper losses even when cash flow is positive.
For pass-through entities, the NOL flows through to the owner's personal return. It can offset other types of income (wages, investment income) subject to the excess business loss limitation, which caps business losses that can offset non-business income at $305,000 (single) or $610,000 (married filing jointly) for 2025.
Strategic use of NOLs involves timing income and deductions to maximize the benefit. If you have NOL carryforwards, accelerating income recognition into years where you can offset it with prior losses can effectively make that income tax-free.
Practical Example
A restaurant opens with $200,000 in startup costs and first-year losses. This creates a $200,000 NOL. In year two, the restaurant earns $150,000 in profit. The NOL offsets 80% of the profit ($120,000), so only $30,000 is taxable. The remaining $80,000 NOL carries forward to year three.