Net Operating Loss (NOL) Strategies for Small Businesses: Carryforward Rules and Planning

By Yarik Yarosh, CPA ·September 5, 2026 ·7 min read

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

A net operating loss occurs when a business’s tax deductions exceed its income for the year. For small businesses, this most commonly happens in Year 1 (startup costs and equipment purchases exceed revenue), during an economic downturn, or after a casualty loss. The NOL rules determine how that loss can offset income in other years.

✓Key takeaway

Current NOL rules (post-TCJA, post-CARES Act):

Carryforward only. NOLs arising in tax years beginning after December 31, 2020 can be carried forward indefinitely. There is no carryback (the CARES Act temporarily allowed 5-year carryback for 2018-2020 NOLs, but that has expired). The NOL is computed on Form 1045 or as part of Form 1040.
80% limitation. NOLs carried forward can offset only 80% of taxable income in the carryforward year. The remaining 20% is taxed. This means a business with a $100,000 NOL carryforward and $120,000 of current-year income can use $96,000 of the NOL (80% of $120,000), leaving $24,000 taxable and $4,000 of NOL carried forward to the next year.
C-Corp NOLs stay at the entity level. A C-Corporation’s NOL can only offset the C-Corp’s own future income. It does not pass through to shareholders. If the C-Corp is dissolved or converted, unused NOLs may be lost (subject to IRC 381 and 382 limitations).
S-Corp and partnership losses pass through. The entity itself does not carry an NOL. Instead, losses flow through to the owners on Schedule K-1. The owner can use the loss against other income (wages, investment income) subject to three layers of limitations:
- Basis limitation (IRC 1366/704(d)): the owner can deduct losses only up to their stock basis (S-Corp) or partnership interest basis.
- At-risk limitation (IRC 465): losses are further limited to the amount the owner has at risk (invested capital, recourse debt).
- Passive activity limitation (IRC 469): if the owner does not materially participate in the business, the loss is passive and can only offset passive income.
Excess business loss limitation (IRC 461(l)). Non-corporate taxpayers (individuals, including S-Corp and partnership owners) cannot deduct business losses exceeding $305,000 (single) or $610,000 (MFJ) for 2025 against non-business income. Excess losses become NOL carryforwards subject to the 80% rule.
Ordering of loss limitations. Each limitation is applied in sequence. A loss must survive all four to produce a current-year deduction:
- At-risk rules (IRC 465)
- Passive activity loss rules (IRC 469)
- Excess business loss limitation (IRC 461(l))
- NOL rules (IRC 172)
NOL carryforwards do not reduce self-employment tax. SE tax is computed on current-year net self-employment income regardless of any NOL carryforward. A sole proprietor with $100,000 net SE income and a $100,000 NOL carryforward still owes $14,130 in SE tax; the NOL only reduces income tax.

How does the basic NOL carryforward and 80% limitation work?

Hypothetical example

Round numbers. A new restaurant opens in 2026 and has a $50,000 loss in its first year (startup costs, build-out depreciation, pre-opening expenses exceed revenue). The owner has no other income.

2026: Business loss: ($50,000). Other income: $0. NOL generated: $50,000. Tax owed: $0. NOL carryforward: $50,000.

2027: Business profit: $80,000. NOL deduction: 80% of $80,000 = $64,000 (but the NOL is only $50,000, so the full $50,000 is used). Taxable income: $80,000 - $50,000 = $30,000.

If the 2026 loss were $100,000 and 2027 profit were $80,000: NOL deduction limited to 80% of $80,000 = $64,000. Taxable income: $80,000 - $64,000 = $16,000. Remaining NOL carryforward to 2028: $100,000 - $64,000 = $36,000.

The 80% limitation means the owner always pays some tax in profitable years, even with an NOL carryforward.

Planning note on estimated taxes: Because the 80% limit ensures some taxable income each year, the owner should make estimated tax payments starting in Year 2 even with a large NOL. The prior year safe harbor ($0 Year 1 tax) makes Year 2 safe, but Year 3 requires actual estimated payments.

Common NOL triggers for small businesses: startup costs exceeding first-year revenue, large equipment purchases with bonus depreciation, cost segregation studies creating large depreciation deductions, economic downturns, and casualty losses.

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

What’s the excess business loss limitation?

Before the NOL calculation, the excess business loss limitation (IRC 461(l)) caps the amount of business losses that can offset non-business income in any year. Business losses exceeding $305,000 (single) or $610,000 (MFJ) are disallowed and treated as an NOL carryforward.

This primarily affects business owners with large Section 179 deductions or significant startup losses who also have substantial non-business income (a spouse’s wages, investment income). The disallowed excess is not lost; it becomes an NOL carryforward subject to the 80% limitation in future years.

Hypothetical example

Round numbers. A sole proprietor purchases $400,000 in equipment (Section 179) for a new construction company. The business has $200,000 in revenue and $400,000 in Section 179 plus $100,000 in other expenses. Business loss: ($300,000). The owner’s spouse earns $150,000 in W-2 wages (MFJ filing).

Excess business loss limitation: business losses are limited to $610,000 (MFJ). The $300,000 loss is under the limit, so the full amount is allowed.

Combined income: $150,000 (spouse wages) - $300,000 (business loss) = ($150,000) net loss. NOL generated: $150,000. Tax owed: $0.

2028: construction company earns $200,000 profit. Spouse earns $150,000. Combined income: $350,000. NOL deduction: 80% of $350,000 = $280,000, but the NOL is only $150,000. Full NOL used. Taxable income: $200,000.

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

How do NOL carryforwards work for a typical small business?

Hypothetical example

Round numbers. A new S-Corp has a $50,000 loss in Year 1 (startup costs, equipment Section 179, low revenue). The sole owner has $80,000 in W-2 income from a day job.

Year 1:

S-Corp K-1 loss: ($50,000)
Owner’s stock basis: $30,000 (cash invested in the S-Corp)
Basis limitation: owner can deduct only $30,000 of the $50,000 loss this year
Suspended loss (carried forward at the shareholder level): $20,000
Deductible loss: $30,000 against the owner’s $80,000 W-2 income
Owner’s taxable income: $80,000 - $30,000 = $50,000
Tax savings (22% bracket): approximately $6,600

Year 2:

S-Corp K-1 income: $40,000
The $20,000 suspended loss from Year 1 is now available (basis has been restored by the current year’s income)
Net K-1 income after suspended loss: $40,000 - $20,000 = $20,000
Owner’s total income: $80,000 (W-2) + $20,000 (K-1) = $100,000

Planning note: increasing basis to use more of the Year 1 loss. If the owner had loaned an additional $20,000 to the S-Corp (documented with a promissory note), the Year 1 basis would have been $50,000 ($30,000 stock + $20,000 debt basis), and the full $50,000 loss would have been deductible in Year 1. Tax savings: $11,000 instead of $6,600. The additional $4,400 in savings for making a $20,000 loan (that the S-Corp can repay in Year 2) is a meaningful planning opportunity.

C-Corp comparison: If the same business were a C-Corporation with a $50,000 Year 1 loss:

The loss stays at the C-Corp level. The owner gets no personal tax benefit.
The C-Corp carries the loss forward to Year 2 and offsets $40,000 of Year 2 income (80% x $40,000 = $32,000 usable, but the loss exceeds income, so the full $40,000 is offset, leaving $10,000 carried forward)
The owner’s $80,000 W-2 income is unaffected
Total tax savings: lower C-Corp tax in Year 2 (21% x $40,000 = $8,400 saved), but the owner’s personal tax is unchanged

For owners with other income sources, the S-Corp’s pass-through loss is almost always more valuable than the C-Corp’s entity-level NOL carryforward.

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

Related guides:

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) Strategies for Small Businesses: Carryforward Rules and Planning." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-net-operating-loss-nol-strategies

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