Net Operating Losses for Small Business Owners: How the Carryforward Works and Why It Matters

Starting a business often means losing money before making it. The IRS actually accounts for this. The Net Operating Loss (NOL) rules allow you to offset future profitable years with losses from less profitable ones—which is one of the reasons tax planning across years matters more than looking at any single year in isolation.

What Is an NOL?

A Net Operating Loss can occur when allowable deductions exceed income for the year, after the NOL rules make specific adjustments. Not every deduction creates one—capital losses and certain other items are excluded from the NOL calculation—but operating losses from your trade or business generally qualify. For pass-through entities, the business loss flows to the owner first, and any resulting NOL is generally calculated at the individual level after the owner-level limitations are applied.

The Current Rules (Post-TCJA)

Before 2018, NOLs could be carried back two years and carried forward 20 years. The Tax Cuts and Jobs Act changed this: carrybacks were largely eliminated for non-farming businesses, carryforwards are now indefinite (no 20-year limit), and the offset is capped at 80% of taxable income in any given year. This last point is the one most people miss.

If you had a $150,000 NOL carryforward and $100,000 of taxable income in the current year, you generally could only use $80,000 of the NOL against that year’s taxable income. The remaining $70,000 carries forward.

How NOLs Work for Pass-Through Owners

S-Corp and partnership losses flow through to owners' personal returns through Schedule K-1. The individual—not the entity—tracks the resulting NOL. However, losses must first clear basis limitations, at-risk rules, passive activity loss rules, and the excess business loss limitation before they can create or increase a usable NOL. These limitations can delay or reduce how much of a pass-through loss you can use in the current year. C-Corporations have their own entity-level NOL with the same 80% cap and indefinite carryforward.

Tracking Your NOL

The NOL doesn't apply automatically. It has to be included in your return, and your tax preparer should be maintaining a carryforward schedule from year to year. If you've had loss years and no one has talked to you about an NOL carryforward, that's a gap worth addressing. he carryforward is a tax attribute. It can reduce future taxes and should be factored into forward-looking tax planning.

Why This Matters

Many new business owners have several rough years before they hit consistent profitability. If those early losses were properly tracked, they can substantially reduce the tax bill in later profitable years. This is not an obscure tax shelter—it's the basic tax rule that says if your business lost money, you shouldn't be taxed as if it didn't. Make sure someone is tracking it.