Business Deductions

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Small Business Deductions: Business Losses vs NOLs

Business Losses versus Net Operating Losses (NOLs)

For tax purposes, the terms business loss and a net operating loss are not defined the same way when applied to C-corporations and to individuals.

C-corporations:

For tax purposes, when a C-corporation reports a net loss (e.g., expenses exceed income) on Form 1120 (instructions) the loss is referred to as a net operating loss.

A net operating loss is used to reduce corporate income of other years. Shareholders don't get to deduct C-corporation net losses on their own tax return.

Individuals:

Individuals may also incur a net operating loss when preparing their individual income tax return. A net operating loss may occur when certain deductions exceed income reported on Form 1040 (instructions).

For example, among the variety of items that may cause a net operating loss, the most common cause is a net business loss incurred by a pass-through entity in which the individual has an ownership interest.

Pass-through entities include:

Sole proprietorships
Partnerships
S-corporations
LLCs (where no election was made for the LLC to be taxed as a C-corporation).

Pass-through entities do not pay federal income tax. However, there are some exceptions for older C-corporations that converted to S-corporation status.

Losses incurred by pass-through entities are passed through the entity to each owner. Each owner may deduct his/her share of the loss from other sources of income reported on his/her individual income tax return.

By reducing income from other sources reported on Form 1040 the taxpayer reduces his/her income tax liability.

If a net business loss exceeds all other income reported on Form 1040 a net operating loss will result. The net operating loss may be carried back to reduce income of prior years. It may also be carried forward.

Business Losses and Net Operating Losses: Casualty and Theft Losses; Who can claim a net operation loss?

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