Net Operating Losses in 2026 — How a Business Loss Carries Forward, and the Two Limits That Apply to It
A year in which a business loses money is not a wasted tax year. When deductions exceed income by enough, the result can be a net operating loss that carries forward to offset income in later years. The rules changed significantly after 2017, and two separate limits now govern how much of a loss can be used and when. Here is how net operating losses work under IRS rules for 2026.
What Creates a Net Operating Loss?
Per the IRS instructions for Form 172, a net operating loss arises when a taxpayer's deductions for the year exceed income, and a loss from operating a trade or business is the most common cause. The computation excludes certain items: capital losses in excess of capital gains, nonbusiness deductions in excess of nonbusiness income, and the Section 199A qualified business income deduction are not counted. This is why a large investment loss does not create an NOL, while a loss from an operating business can. Form 172 is used by individuals, estates, and trusts to figure the amount available to carry forward.
The Carryforward Rules After 2017
For net operating losses arising in tax years beginning after 2017, the carryback has been eliminated for most taxpayers, and the loss carries forward indefinitely until it is used. Farming losses retain a two-year carryback. This replaced the earlier rule that allowed a carryback and limited the carryforward to 20 years. A taxpayer must keep records for any year that generates an NOL for three years after the carryforward has been used up, because the loss can remain relevant for many years after it arose.
The 80% Limit
Under Section 172, the deduction for post-2017 net operating losses is limited to 80% of taxable income computed before the NOL deduction, the Section 199A deduction, and the Section 250 deduction. A taxpayer with $100,000 of taxable income and a large NOL carryforward can therefore deduct at most $80,000 of it, and still has $20,000 of taxable income in that year. The unused portion carries forward to the next year, where the same 80% limit applies again. Because of this limit, an NOL can reduce taxable income significantly but cannot eliminate it in a profitable year.
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The Excess Business Loss Limit Comes First
For sole proprietors, partners, and S corporation shareholders, a separate rule applies first. Section 461(l), the excess business loss rule, limits the net business loss a noncorporate taxpayer can deduct against nonbusiness income, such as wages, interest, and capital gains, in a single year, using an annual threshold that is adjusted for inflation. A loss above that threshold is disallowed for the year and is treated as a net operating loss carryforward to the following year. Under the Form 461 instructions for Section 461(l), the taxpayer must keep a record of the excess business loss from each year, and it is then subject to the 80% limit in the year it is used. The One, Big, Beautiful Bill made this limitation permanent.
Planning Around a Loss Year
A loss year changes the tax planning calculus in both directions. In the loss year, other income may be offset directly to the extent the loss is deductible, and in later years the carryforward reduces taxable income subject to the 80% cap. A year with unusually low taxable income can also create room for income recognized at lower rates, such as a Roth conversion, which we cover in our guide to Roth conversion planning for business owners. California applies its own business loss limitation, reported on form FTB 3461, so the state calculation should be run separately and not assumed to match the federal result.
How Tax Wealth Consultant Approaches Net Operating Losses
Tax Wealth Consultant determines whether a loss qualifies as a net operating loss or is limited by the excess business loss rule, documents the carryforward on the correct forms, tracks the balance and the 80% limit year over year, and builds tax planning around the carryforward, including when to recognize income. A loss that is tracked correctly stays useful for years, and one that is lost track of is simply forfeited.
A tracked loss keeps working for years. An untracked one is gone.
Schedule your confidential 30-minute review with Tax Wealth Consultant today.
taxwealthconsultant.com | (949) 409-8335
Tax Wealth Consultant provides tax planning, tax preparation, and wealth advisory services for business owners, professionals, and investors in Irvine, Orange County, and beyond.
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