Is It Possible to Turn Business Losses into Tax Savings?
Even the most financially sound businesses can experience challenging years. Whether due to market shifts, rising expenses, or unexpected events, downturns happen. But here’s the silver lining: under the federal tax code, certain business losses may be used strategically to reduce taxable income in future years. This approach, known as the Net Operating Loss (NOL) deduction, can offer significant tax relief when properly applied.
What Is a Net Operating Loss (NOL)?
A Net Operating Loss occurs when a business’s allowable tax deductions exceed its taxable income in a given year. NOLs are designed to help businesses with fluctuating income—allowing them to “smooth out” the tax burden across years by applying losses from unprofitable periods to offset income in profitable ones.
This deduction is particularly helpful for businesses that experience growth cycles, seasonal trends, or economic downturns.
Who Can Use an NOL to Reduce Taxes?
You may be eligible for an NOL deduction if your total deductions surpass your income for the year. These losses must generally be tied to:
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Business operations (e.g., losses reported on Schedule C or F, or pass-through losses from partnerships or S corporations on Schedule K-1)
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Federally declared disaster-related losses, such as casualty or theft
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Rental property losses (Schedule E)
However, not all losses count when calculating an NOL. The following items are generally excluded:
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Capital losses that exceed capital gains
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Gains from the sale of qualified small business stock that are excluded from income
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Nonbusiness deductions that exceed nonbusiness income
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The NOL deduction from a previous year
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Section 199A Qualified Business Income deduction
Eligible filers include individuals and C corporations. While partnerships and S corporations themselves can’t claim an NOL, their partners or shareholders can potentially use their share of the loss on their individual tax returns.
Key Changes to NOL Rules Under the TCJA
The Tax Cuts and Jobs Act (TCJA) brought significant reforms to how net operating losses can be used. Here are the major updates:
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No more carrybacks (except for specific farming losses): You can no longer apply NOLs to previous tax years.
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Unlimited carryforwards: You can carry unused losses forward indefinitely.
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80% cap: NOLs can only offset up to 80% of your taxable income in a future year.
If your NOL is larger than your taxable income in a particular year, the remaining amount becomes a carryover and can be used in future years. It’s important to apply NOLs in the order they were incurred.
What Is the Excess Business Loss Limitation?
Beginning in 2021, the TCJA introduced the Excess Business Loss (EBL) limitation for noncorporate taxpayers, including partners and S corporation shareholders. This rule applies after accounting for other loss limitations such as basis, at-risk, and passive activity rules.
Under this provision, only a portion of your business loss can offset income. For the 2025 tax year, the threshold is:
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$313,000 for individuals
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$626,000 for joint filers
Any losses beyond this threshold become NOL carryforwards—again subject to the 80% limitation in the years they’re used. This reduces the immediate tax benefit of those losses.
Note: The Inflation Reduction Act extended the EBL limitation through 2028. Originally, it was set to expire after 2026.
Why Strategic Tax Planning Matters
Understanding and utilizing the NOL deduction properly requires careful attention to detail. Coordinating it with other credits, deductions, and loss limitations is critical to ensure you’re maximizing your tax benefits.
Smart tax planning can make a significant difference. Applying your business losses the right way could save you thousands—or more—over time.
Let’s Build a Tax Strategy Around Your Losses
If your business has experienced a loss year, you don’t have to let it go to waste. We can help you determine if you’re eligible for an NOL deduction and develop a strategy that aligns with your short- and long-term goals.
Contact us today to explore how you can turn business losses into a powerful tax-saving tool.
