Net Operating Loss - Explained
What is a Net Operating Loss?
Written by J. Mance Gordon
Updated at April 18th, 2024
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What is a Net Operating Loss (NOL)?
A net operating loss (NOL) occurs when the expenses of a taxpayer or company often exceeded the revenues. At this period, taxpayers and companies often receive tax relief to cover up for that year and reduce tax burdens in the future.
How is a Net Operating Loss (NOL) Used?
A net operating loss, when recorded by a company or individual taxpayer, results in an unprofitable accounting period or year. Usually, the Internal Revenue Service in the United States offers tax relief to taxpayers when they record such loss. This is due to the absence of taxable income for that accounting period. For instance, if the taxable income of a taxpayer is $50,000 and the allowable tax deductions amount to $75,000, the net operating loss is $25,000. Since there is no taxable income left to be taxed, such taxpayer pays no taxes, also, NOL can be applied to future tax payments, that means if a company recorded an NOL the previous years, the NOL can be put forward which will reduce income tax payments in the present year.
Rules for Applying an NOL
There are certain guidelines or rules for applying a net operating loss in businesses. Aside from the fact that a business can bring the NOL of a previous year forward to enjoy tax reductions in the present year, there are other ways NOL can be applied. In some cases, the outstanding taxable amount that a company has can be used to claim a taxable income refund if the company qualifies for such a refund. NOLs can also be carried forward by a business for up to 20 years but after a period of 20 years, NOLs that are left are canceled.
Section 382 Limitation
A net operation loss offers a company or a taxpayer tax relief by reducing the amount of income of the company that can be taxed by the Internal Revenue Service. Due to the benefits that taxpayers derive from NOLs, taxpayers go to various lengths of enjoying the tax reductions. Section 382 of the Internal Revenue Code, however, restricts companies from acquiring a company in order to use its NOL tax benefits. As contained in Section 382, only a part of the NOL of the acquired company can be used by the acquirer in each concurrent year if the change in ownership is beyond 50%.