# Net Operating Loss (NOL): Definition, Carryforward Rules, and Tax Planning

Published: 2026-03-17
Author: Warren Team
URL: https://www.heywarren.com/blog/nol-carryforward

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When a business's deductible expenses exceed its taxable income for the year, the [IRS](https://www.irs.gov/) doesn't simply discard the excess. That negative taxable income — a net operating loss — becomes a valuable tax asset that can offset future profitable years. Understanding NOLs is essential for startups, cyclical businesses, and anyone investing in early-stage companies, because NOLs represent real future tax savings sitting on the balance sheet.

## What Is a Net Operating Loss (NOL)?

A net operating loss (NOL) occurs when a taxpayer's allowable deductions exceed their gross income for the tax year. In simple terms: the business spent more (in deductible expenses) than it earned, creating negative taxable income.

**Formula**: Net Operating Loss = Deductible Expenses − Gross Income (when result is negative)

**Example**: A startup has $2 million in revenue but $5 million in operating expenses in Year 1.
- Taxable income: $2M − $5M = **−$3 million** (a $3M NOL)
- No taxes are owed in Year 1
- The $3M NOL can be used to reduce taxes in future profitable years

At a 21% corporate tax rate, this $3M NOL is worth $630,000 in future tax savings — a real asset reflected on the balance sheet as a **deferred tax asset**.

## Individual vs. Corporate NOLs

Both individuals and corporations can have NOLs, but the rules differ slightly:

**Corporate NOLs** are generated by C corporations when business deductions exceed revenues. They follow the corporate tax carryforward rules described below.

**Individual NOLs** arise primarily from:
- Business losses from sole proprietorships or single-member LLCs (reported on Schedule C)
- Farm losses
- Casualty losses from federally declared disasters
- Employee business expenses exceeding income in very specific circumstances

Passive activity losses (from limited partnership interests or rental properties with limited personal involvement) are NOT NOLs — they follow separate passive activity loss rules and can generally only offset passive income.

## NOL Carryforward Rules: Pre- and Post-Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) of 2017 fundamentally changed NOL carryforward rules:

![How the Tax Cuts and Jobs Act of 2017 changed NOL carryback, carryforward, and offset rules.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20149%22%20width%3D%22800%22%20height%3D%22149%22%20role%3D%22img%22%3E%3Ctitle%3ETimeline%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Cline%20x1%3D%22137.5%22%20y1%3D%2255%22%20x2%3D%22662.5%22%20y2%3D%2255%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%223%22%2F%3E%3Ccircle%20cx%3D%22137.5%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22137.5%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E1%3C%2Ftext%3E%3Ctext%20x%3D%22137.5%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EPre-2018%20NOLs%3C%2Ftext%3E%3Ctext%20x%3D%22137.5%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E2yr%20carryback%2C%2020yr%20forwa%E2%80%A6%3C%2Ftext%3E%3Ccircle%20cx%3D%22312.5%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22%232563eb%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%223%22%2F%3E%3Ctext%20x%3D%22312.5%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22white%22%3E2%3C%2Ftext%3E%3Ctext%20x%3D%22312.5%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ETCJA%202017%3C%2Ftext%3E%3Ctext%20x%3D%22312.5%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3EEliminated%20carryback%2C%20ind%E2%80%A6%3C%2Ftext%3E%3Ccircle%20cx%3D%22487.5%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22487.5%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E3%3C%2Ftext%3E%3Ctext%20x%3D%22487.5%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EPost-2017%20NOLs%3C%2Ftext%3E%3Ctext%20x%3D%22487.5%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3ENo%20carryback%2C%20no%20expiry%2C%20%E2%80%A6%3C%2Ftext%3E%3Ccircle%20cx%3D%22662.5%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22662.5%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E4%3C%2Ftext%3E%3Ctext%20x%3D%22662.5%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ECARES%20Act%202020%3C%2Ftext%3E%3Ctext%20x%3D%22662.5%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E5yr%20carryback%20restored%20fo%E2%80%A6%3C%2Ftext%3E%3C%2Fsvg%3E)

*How the Tax Cuts and Jobs Act of 2017 changed NOL carryback, carryforward, and offset rules.*

### Before TCJA (for losses before 2018)
- **Carryback**: Could carry losses back 2 years to receive tax refunds on previously paid taxes
- **Carryforward**: Could carry losses forward up to 20 years
- **Full offset**: Could use NOLs to eliminate 100% of future taxable income

### After TCJA (for losses from 2018 onward)
- **No carryback** (for most businesses — exception for farming losses, which still get 2-year carryback)
- **Indefinite carryforward**: No expiration limit
- **80% limitation**: In any given year, NOLs can only offset up to 80% of taxable income — minimum 20% of income is always taxed

**COVID Exception**: The CARES Act of 2020 temporarily reinstated 5-year carryback for NOLs arising in 2018, 2019, and 2020, allowing companies to apply these losses against prior profitable years and receive immediate tax refunds.

## How the 80% Limitation Works

**Example**: A company has $10 million in taxable income in Year 5 and $12 million in NOL carryforwards from prior years.

![With a $10M taxable income and $12M NOL carryforward, the 80% cap leaves $2M still taxable.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20210%22%20width%3D%22800%22%20height%3D%22210%22%20role%3D%22img%22%3E%3Ctitle%3EComparison%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Ctext%20x%3D%22230%22%20y%3D%2257.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ENOL%20Used%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%2225%22%20width%3D%22450%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%232563eb%22%2F%3E%3Ctext%20x%3D%22702%22%20y%3D%2257.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%232563eb%22%3E%248.0M%3C%2Ftext%3E%3Ctext%20x%3D%22230%22%20y%3D%22152.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ETaxable%20Income%20Remaining%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%22120%22%20width%3D%22112.5%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%237c3aed%22%2F%3E%3Ctext%20x%3D%22364.5%22%20y%3D%22152.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%237c3aed%22%3E%242.0M%3C%2Ftext%3E%3C%2Fsvg%3E)

*With a $10M taxable income and $12M NOL carryforward, the 80% cap leaves $2M still taxable.*

Without the 80% limitation: Could eliminate all $10M of income ($12M NOL > $10M income)

With the 80% limitation:
- Maximum NOL usage: $10M × 80% = $8M
- Remaining taxable income: $10M − $8M = **$2M** (taxed at 21% = $420,000 in taxes)
- Remaining NOL carryforward: $12M − $8M = **$4M** (carried to future years)

Companies with large NOL carryforwards will always owe *some* taxes in profitable years under current law, even if the carryforward exceeds their income.

## NOLs in Financial Statements

When a company has NOL carryforwards, they appear on the balance sheet as **[deferred tax assets](/blog/deferred-tax-assets)** (DTAs):

![How a net operating loss flows from the income statement to a deferred tax asset on the balance sheet.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20875%20125%22%20width%3D%22875%22%20height%3D%22125%22%20role%3D%22img%22%3E%3Ctitle%3EFlow%20diagram%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2230%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22115%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EOperating%20Loss%3C%2Ftext%3E%3Ctext%20x%3D%22115%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EExpenses%20%26gt%3B%20Revenue%3C%2Ftext%3E%3Cline%20x1%3D%22205%22%20y1%3D%2262.5%22%20x2%3D%22237%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22244%2C62.5%20235%2C57.5%20235%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22245%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22330%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ENOL%20Generated%3C%2Ftext%3E%3Ctext%20x%3D%22330%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ENegative%20taxable%20income%3C%2Ftext%3E%3Cline%20x1%3D%22420%22%20y1%3D%2262.5%22%20x2%3D%22452%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22459%2C62.5%20450%2C57.5%20450%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22460%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22545%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EDeferred%20Tax%20Asset%3C%2Ftext%3E%3Ctext%20x%3D%22545%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ENOL%20%C3%97%20tax%20rate%3C%2Ftext%3E%3Cline%20x1%3D%22635%22%20y1%3D%2262.5%22%20x2%3D%22667%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22674%2C62.5%20665%2C57.5%20665%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22675%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22760%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EValuation%20Allowance%3C%2Ftext%3E%3Ctext%20x%3D%22760%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EReduces%20DTA%20if%20unlikely%3C%2Ftext%3E%3C%2Fsvg%3E)

*How a net operating loss flows from the income statement to a deferred tax asset on the balance sheet.*

**DTA = NOL Carryforward × Tax Rate**

**Example**: $30M in NOL carryforwards at 21% corporate rate = **$6.3M deferred tax asset**

### Valuation Allowance

A deferred tax asset for NOLs is only valuable if the company will actually be profitable enough to use the NOL. Under ASC 740, if it's "more likely than not" that some or all of the DTA won't be realized, a **valuation allowance** must reduce the DTA to its expected realizable value.

A full valuation allowance is common for:
- Pre-revenue startups
- Companies with multiple years of consecutive losses
- Companies in declining industries

When a company reverses its valuation allowance (because profitability improves), it recognizes a non-cash income gain. This is why companies like Amazon in its early profitable years reported large non-cash income items from DTA releases — not reflective of core operating performance.

## Section 382 Limitations

When a company undergoes a significant ownership change (more than 50% ownership change over a rolling 3-year period), **Section 382 of the Internal Revenue Code** severely limits the ability to use pre-existing NOL carryforwards.

The annual Section 382 limitation = (Company's value at change date) × (Federal long-term tax-exempt rate)

**Example**: A startup worth $100M undergoes an ownership change (VC funding round crosses the 50% threshold). With the long-term tax-exempt rate at 3%, the annual NOL usage is capped at $3M per year, regardless of profits.

If the company has $50M in NOL carryforwards and is limited to $3M/year, it would take 16+ years to use those NOLs — potentially wasting significant tax value if the company's NOLs expire (older pre-2018 NOLs have 20-year limits) or if circumstances change.

Section 382 is one of the most significant tax considerations in M&A transactions — acquirers and targets must assess whether existing NOLs are limited and how valuable they'll actually be post-transaction.

## Tracking NOLs for Tax Planning

### Individual Business Owners

Track NOLs carefully:
- Pre-2018 NOLs have 20-year expiration and different carryback rules
- Post-2017 NOLs are indefinite but subject to 80% limitation
- Keep detailed records of when each NOL was generated (for calculating Section 382 limitation periods)

### Investors and Analysts

When evaluating companies with significant NOL carryforwards:

1. **Check the DTA balance**: Large DTAs from NOLs = significant future tax shield if profitable
2. **Check the valuation allowance**: A full allowance means management doesn't believe profitability is likely — a bearish signal
3. **Model Section 382 exposure**: If the company has raised equity capital recently, check whether Section 382 limits the NOL utilization rate
4. **Adjust EPS**: NOL releases that boost reported EPS are non-recurring — exclude them from core earnings analysis

## State NOL Rules

Each state has its own NOL carryforward rules, which often differ materially from federal rules:

- Some states don't allow NOL carrybacks or carryforwards at all
- Some have shorter carryforward periods (10 years instead of indefinite)
- Some haven't conformed to the TCJA's 80% limitation (still allow 100% offset)
- Some have lower carryback periods than federal

For multi-state businesses, state NOL planning adds complexity and requires state-level analysis.

## Conclusion

Net operating losses are one of the most valuable tax assets a business can generate — they represent real future tax savings that can make the difference between profitable and unprofitable periods in the business cycle. For investors, understanding NOL carryforwards and their limitations (the 80% rule, Section 382, valuation allowances) is essential for accurately modeling a company's future tax rate and true after-tax earnings power.

For related tax and financial analysis topics, see our guides on [deferred tax assets](/blog/deferred-tax-assets), [EBITDA to EV](/blog/ebitda-to-ev), and [year-over-year analysis](/blog/year-over-year).

Warren at [heywarren.com](https://heywarren.com) helps investors understand complex tax and accounting concepts that affect valuation and investment decisions.

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## Related Reading

**More from Warren**:
- [Deferred Tax Assets: What They Are, How They Work, and Why They Matter](/blog/deferred-tax-assets)
- [Fringe Benefits: What They Are, Tax Treatment, and Why They Matter for Compensation](/blog/fringe-benefits)
- [1035 Exchanges: How to Transfer Annuities and Life Insurance Without Paying Taxes](/blog/1035-exchanges)

**Authoritative sources**:
- [IRS — Tax Topics](https://www.irs.gov/taxtopics)
- [IRS Publication 17 — Your Federal Income Tax](https://www.irs.gov/pub/irs-pdf/p17.pdf)
- [Tax Foundation — Research](https://taxfoundation.org/research/)