When business losses exceed business income, a net operating loss may exist.
Net operating losses can be complicated. This post will use a simplified example. For more details and technicalities, consult IRS Publication 536.
This example is modified from Publication 536.
Glenn, who is single, owns a business. He also works a part-time job, where he earned $1,500 for the year. He also had interest from a savings account of $100. His total income is $1,600.
His business suffered a net loss of $5,000 for the year. Glenn claims the standard deduction of $6,200 and a personal exemption of $3,950, so his total deductions are $15,150,.
For the year, Glenn’s deductions exceed his income by $13,550 (income of $1,600 – $5,000 business loss – $10,150 deductions). However, this is not his net operating loss.
To calculate the NOL, Glenn must first adjust his deductions by taking out his personal exemption and the difference between his standard deduction and non-business income. For purposes of this calculation, Glenn’s wages from his part-time job count as business income.
Adjustment to Deductions
- $15,150 total deductions
- Minus $3,950 standard deduction
- Minus $6,100 (the difference between his non-business income of $100 and his standard deduction of $6,200)
- Equals $5,100 adjusted deductions
- Then we calculate the net operating loss
Net Operating Loss
- $1,600 total income, minus
- $5,100 adjusted deductions
- $3,500 net operating loss
Glenn can carry this $3,500 loss back up to 2 years to offset his income in those prior years. Any remaining NOL can be carried forward for up to 20 years.
Again, this is a highly simplified example, and there are a lot of particulars that can muddy the waters with NOLs. Consult IRS Publication 536 for more details.
And for more tax terms, visit the Glossary page on this website.
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