Net Operating Loss (NOL) Rules for Small Businesses

By Yarik Yarosh, CPA ·September 5, 2026 ·4 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

A net operating loss (NOL) occurs when a taxpayer’s allowable deductions exceed gross income for the year. For small business owners, this typically happens in the startup year (large equipment purchases create depreciation deductions exceeding income) or during a downturn. Under current law (as modified by the TCJA and CARES Act, codified in IRC 172), NOLs arising in tax years beginning after December 31, 2020 carry forward indefinitely but are limited to 80% of taxable income in the carryforward year. There is no carryback period (with a narrow exception for farming losses, which can be carried back 2 years).

✓Key takeaway

Current NOL rules (tax years beginning after 2020):

Carryforward:

NOLs carry forward indefinitely (no expiration)
Limited to 80% of taxable income in the carryforward year
The 80% limit means at least 20% of income is always taxable, regardless of how large the NOL is
Multiple years of NOLs stack (they accumulate)

No carryback:

NOLs cannot be carried back to prior years (exception: farming losses, 2-year carryback)
The CARES Act temporarily allowed a 5-year carryback for NOLs arising in 2018-2020, but that provision has expired

80% limitation example:

Year 1 NOL: $100,000
Year 2 taxable income (before NOL): $80,000
NOL allowed: 80% x $80,000 = $64,000
Year 2 taxable income (after NOL): $16,000
Remaining NOL carryforward: $100,000 - $64,000 = $36,000

How NOLs are created (common business scenarios):

Large equipment purchases with bonus depreciation in Year 1
Startup costs exceeding first-year revenue
Business downturn (expenses exceed revenue)
Cost segregation study creating large depreciation deductions
Casualty losses

Excess business loss limitation (IRC 461(l)): Before the NOL rules apply, excess business losses are capped at $305,000 (single) or $610,000 (MFJ) for 2024. Business losses exceeding this threshold are converted to an NOL carryforward (they don’t disappear, they’re just recharacterized). This limitation applies BEFORE the NOL calculation, so the actual NOL may be smaller than the total business loss.

Ordering of loss limitations:

At-risk rules (IRC 465)
Passive activity loss rules (IRC 469)
Excess business loss limitation (IRC 461(l))
NOL rules (IRC 172)

Each limitation is applied in sequence. A loss must survive all four to produce a current-year deduction.

How do NOLs work with large depreciation?

Hypothetical example

Round numbers. A construction company (sole proprietor, single filer) buys $300,000 in equipment in Year 1 with 100% bonus depreciation.

Year 1:

Revenue: $200,000
Operating expenses: $150,000
Net profit before depreciation: $50,000
Bonus depreciation: $300,000
Business loss: ($250,000)

Excess business loss check: $250,000 is below the $305,000 single filer threshold. No limitation applies.

NOL: $250,000 (assuming no other income sources)

Year 2:

Revenue: $350,000
Expenses: $200,000
Net profit: $150,000
NOL deduction (80% x $150,000): $120,000
Taxable income: $30,000
Tax: approximately $6,500
Remaining NOL: $130,000

Year 3:

Revenue: $400,000
Expenses: $220,000
Net profit: $180,000
NOL deduction (80% x $180,000): $130,000 (uses remaining NOL, below the 80% cap)
Taxable income: $50,000
Tax: approximately $12,200
Remaining NOL: $0

Total tax over 3 years: $0 + $6,500 + $12,200 = $18,700

Without the NOL (same income, no large Year 1 equipment purchase):

Year 1 tax (on $50,000): $11,600
Year 2 tax (on $150,000): $35,000
Year 3 tax (on $180,000): $44,000
Total: $90,600

Tax savings from the equipment purchase and NOL: $90,600 - $18,700 = $71,900

The total tax savings is the same whether you think of it as depreciation ($300,000 x 39.3% = approximately $117,900 in lifetime savings, spread across years as the NOL is used) or as the time-value benefit of deferring tax to later years. The 80% limitation means the NOL takes 2-3 years to use up rather than being fully absorbed in Year 2.

Planning consideration: because the 80% limit ensures some taxable income each year, the owner should make estimated tax payments starting in Year 2 (even though there’s a large NOL). The prior year safe harbor ($0 Year 1 tax) makes Year 2 safe, but Year 3 requires actual estimated payments.

Illustrative numbers only, not a real client and not advice for your facts.

Related guides:

Net Operating Loss (NOL) Carryforward: How to Use Business Losses to Reduce Future Taxes

How do net operating loss carryforward rules work for small businesses?

Net operating losses arising in tax years after 2017 can be carried forward indefinitely but are limited to offsetting 80% of taxable income in any future year under IRC 172(a). The 80% limitation means a business with a large NOL carryforward will always pay some tax in profitable years, unlike pre-TCJA rules that allowed 100% offset. NOLs can no longer be carried back to prior years for most businesses (the CARES Act temporarily allowed 5-year carrybacks for 2018-2020 losses, but that provision has expired). Farming businesses retain a 2-year carryback option, and property and casualty insurance companies retain a 2-year carryback with no 80% limitation, which are the only remaining exceptions to the forward-only rule.

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Cite this page

Yarik Yarosh, CPA. "Net Operating Loss (NOL) Rules for Small Businesses." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-net-operating-loss-nol-rules

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.