Net Operating Losses for Small Businesses: Carryforward Rules and the 80% Taxable Income Limit

Q: Can I carry back a net operating loss to get a refund for prior years?

Not under current law for most businesses. The Tax Cuts and Jobs Act eliminated the 2-year NOL carryback for tax years beginning after 2017. The CARES Act temporarily restored a 5-year carryback for tax years 2018-2020, but that window has closed. For tax years beginning after 2020, NOLs carry forward only (indefinitely, subject to the 80% limitation). The one exception is farming losses: farmers can elect a 2-year carryback under IRC 172(b)(1)(B).

Q: 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).

By Yarik Yarosh, CPA ·September 5, 2026 ·5 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 deductions exceed its income for the year. This happens most commonly in the startup phase (before revenue covers expenses) or in years with large equipment purchases (Section 179 or bonus depreciation). Under current law, NOLs carry forward indefinitely but are limited to 80% of taxable income in the year they’re used. Understanding these rules matters because they affect how much tax the business pays in profitable years following a loss year.

✓Key takeaway

NOL rules under current law (post-TCJA, as modified by CARES Act and subsequent legislation):

Creation:

An NOL arises when total deductions (including business losses) exceed total gross income
Computed on Form 1045 or as part of Form 1040

Carryforward:

NOLs carry forward indefinitely (no expiration)
No carryback (the 2-year carryback was eliminated by TCJA, temporarily restored by the CARES Act for 2018-2020, and is not available for tax years beginning after 2020)

80% limitation:

In the carryforward year, the NOL deduction is limited to 80% of taxable income (before the NOL deduction)
This means a business can never fully eliminate its tax liability using NOL carryforwards alone (20% of income is always taxable)
The remaining unused NOL continues to carry forward

Self-employment tax:

NOL carryforwards don’t reduce self-employment tax
SE tax is computed on current-year net self-employment income
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

Excess business loss limitation (IRC 461(l)):

For non-corporate taxpayers: business losses exceeding $305,000 (single) or $610,000 (MFJ) in 2024 aren’t allowed as a current-year deduction
The excess becomes an NOL carryforward
This limits the ability to offset large non-business income (W-2, investment) with business losses in a single year

How do NOL rules work in practice for a small business?

Hypothetical example

Round numbers. A sole proprietor starts a construction business. Year 1 involves large equipment purchases.

Year 1:

Revenue: $200,000
Operating expenses: $150,000
Equipment purchased (Section 179 + bonus depreciation): $250,000
Net business loss: $200,000 - $150,000 - $250,000 = ($200,000)
The owner also has $50,000 in W-2 income from a part-time consulting role
Total income: $50,000 - $200,000 = ($150,000)
Excess business loss check: the $200,000 business loss exceeds the $305,000 threshold (single). No, it doesn’t ($200,000 < $305,000). The full loss is allowed.
NOL for Year 1: $150,000 (after offsetting the $50,000 W-2 income)
Actually, let me be precise. Taxable income before NOL: $50,000 (W-2) - $200,000 (business loss) = ($150,000). This $150,000 NOL carries forward.

Year 2:

Revenue: $300,000
Operating expenses: $180,000
No major equipment purchases
Net business income: $120,000
SE tax on $120,000: $16,942 (NOL doesn’t reduce SE tax)
Taxable income before NOL: $120,000 - $8,471 (half SE) - $15,000 (standard deduction) - $24,000 (QBI) = $72,529
NOL deduction (limited to 80% of taxable income): $72,529 x 80% = $58,023
Available NOL: $150,000 (more than enough)
Taxable income after NOL: $72,529 - $58,023 = $14,506
Income tax: approximately $1,500
Remaining NOL carryforward: $150,000 - $58,023 = $91,977

Total Year 2 tax: $16,942 (SE) + $1,500 (income) = $18,442

Without the NOL: income tax would have been approximately $11,200, so the NOL saved $9,700 in income tax.

Year 3:

Net business income: $140,000
SE tax: $19,776
Taxable income before NOL: approximately $85,000
NOL deduction (80%): $68,000
Taxable income after NOL: $17,000
Income tax: approximately $1,800
Remaining NOL carryforward: $91,977 - $68,000 = $23,977

Year 4:

Net business income: $150,000
Taxable income before NOL: approximately $90,000
NOL deduction (80%): $72,000, but only $23,977 remaining
NOL deduction used: $23,977
NOL fully absorbed

Summary:

Year 1: $150,000 NOL created by equipment purchases
Year 2: $58,023 NOL used, saving approximately $9,700
Year 3: $68,000 NOL used, saving approximately $11,000
Year 4: $23,977 NOL used, saving approximately $4,000
Total income tax saved by the NOL: approximately $24,700

The SE tax problem: In Years 2, 3, and 4, the owner paid $56,160 in self-employment tax ($16,942 + $19,776 + $19,442) that the NOL could not reduce. If the business had been structured as an S-Corp from Year 2 onward, the SE tax would have been limited to the owner’s reasonable salary, and the NOL would have reduced income tax on the distributions. This is a planning opportunity often missed.

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

Can I carry back a net operating loss to get a refund for prior years?

Not under current law for most businesses. The Tax Cuts and Jobs Act eliminated the 2-year NOL carryback for tax years beginning after 2017. The CARES Act temporarily restored a 5-year carryback for tax years 2018-2020, but that window has closed. For tax years beginning after 2020, NOLs carry forward only (indefinitely, subject to the 80% limitation). The one exception is farming losses: farmers can elect a 2-year carryback under IRC 172(b)(1)(B). If you had an NOL in 2018-2020 and did not file amended returns to claim the CARES Act carryback, you may still be able to file (the statute of limitations for refund claims is generally 3 years from the filing date or 2 years from payment). Consult a CPA to determine if a late carryback claim is viable.

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 Losses for Small Businesses: Carryforward Rules and the 80% Taxable Income Limit." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-net-operating-loss-rules

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

Net Operating Losses for Small Businesses: Carryforward Rules and the 80% Taxable Income Limit

How do NOL rules work in practice for a small business?

Can I carry back a net operating loss to get a refund for prior years?

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

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