Business profits often respond to fluctuations in the economy. If you've had a hard year, you might dread filing your federal tax returns. However, you could actually get some good news. You may be eligible for a net operating loss (NOL). If that doesn't sound very pleasant, consider this: Your NOL might help you get a refund from past years or reduce the amount you owe in the future. Sound better now?
Individuals, estates and trusts may also use NOL if their deductions are more than their income. However, it's most common to see a net operating loss because business profits are less than expenses. Other problems that contribute to NOL are theft, damage to property, natural disasters, business or work expenses, moving costs and rental property expenses. Certain deductions, such as personal exemptions and capital losses that are more than capital gains, can't be used to figure your NOL. In addition, partnerships or S corporations aren't allowed to apply for a NOL because any losses are passed onto the partners and shareholders, who include those deductions on their personal tax returns. A C corporation may make use of a NOL, however.
Internal Revenue Service Form 1045, Schedule A, is available to help you determine if you qualify for NOL. You begin by entering the difference between your adjusted gross income and itemized deductions on your 1040 or 1040NR form. Then list a number of other totals, such as non-business deductions, business capital gains and non-business income. You also identify any previous NOL deductions. If you're left with a negative number, you have a NOL.
Typically, business losses reduce taxes in the year they're filed. However, NOL can often be carried back to previous years, and you might be eligible for long-past refunds. For these, you'll have to file IRS Form 1045 or Form 1040X. Estates and trusts can file amendments to returns using Form 1041. You also have the option to carry the loss and apply it to future returns. It's considered a negative amount under "other income." However, if you choose to look ahead, you slam the door on making any historical adjustments.
Determining how to use and apply a NOL is not always simple, but a tax professional may uncover ways to put your deficit to good advantage. Although it's natural to prefer a healthy, sustained profit, it's nice to know that even a business loss doesn't have to be a total loss.