Net Operating Loss Explained
If you have a business, you know that sometimes things don’t go as planned. You might lose money in one year and make up for it the next. But did you know that there’s a way to use those losses to your advantage when it comes to taxes? It’s called a net operating loss (NOL), and here’s what you need to know.
What is Net Operating Loss?
A net operating loss happens when your business expenses exceed its income during an accounting period. In other words, if your business loses more money than it makes in a given year, it has an NOL. This can happen for various reasons such as market changes or investment decisions that didn’t pan out.
How Does Net Operating Loss Work?
When your business has an NOL, you can use it to offset taxable income from previous years or future ones. For example, let’s say your company had $50,000 in taxable income last year but suffered an NOL of $30,000 this year. That means instead of paying taxes on the $50k earnings last year; you would only pay taxes on the difference between both years ($20k) since the remaining amount will be deducted from this tax calculation.
This deduction could help reduce or eliminate the tax burden from previous profitable years of operation. Plus, if there are still some unused deductions left after applying them towards past years’ incomes; they can carry forward for up to 20 years until fully used up.
Who Can Use Net Operating Losses?
Any legal entity with taxable income may have access to NOLs including sole proprietors and individuals with self-employment income who report their businesses on Schedule C of Form 1040 along with partnerships and corporations.
However, not all types of businesses qualify for an NOL claim under Internal Revenue Service (IRS) rules based on certain criteria like annual gross receipts less than $5 million and the nature of the business itself.
When Can You Claim Net Operating Loss?
You can claim an NOL deduction for the tax year in which it occurred or carry back to offset taxable income from up to two previous years. This means you’ll need to file an amended return for each affected year if you want to apply your NOL against earlier years’ incomes.
Alternatively, instead of carrying losses back, you might choose to use them moving forward by carrying them over for up to 20 years. This strategy works best when there’s a potential for future profits that could be offset with those unused deductions.
Final Thoughts
Net operating loss is one way businesses can reduce their tax burden by applying losses from one year towards another. It’s important to keep track of your financial records accurately and understand how this deduction works so that you’ll have everything ready when it comes time to file taxes.