Net Operating Loss (NOL)
A tax designation arising when a company's allowable deductions exceed its taxable gross income, creating a loss that can offset future taxable income.
What is Net Operating Loss?
A net operating loss (NOL) occurs when a business's allowable tax deductions exceed its gross income for the tax year, producing a negative taxable income figure. Rather than losing the tax benefit of these losses, the IRS allows companies to carry NOLs forward to offset future taxable income, reducing future tax payments. Under the Tax Cuts and Jobs Act (2017), NOL carryforwards generated after 2017 can be carried forward indefinitely but can only offset up to 80% of taxable income in any single future year. Pre-2018 NOLs may be carried back 2 years and forward 20 years under prior rules. On the GAAP balance sheet, NOLs generate a deferred tax asset (DTA) because they represent future tax savings. Companies with large NOL carryforwards — such as recently turned-profitable tech companies — may pay minimal cash taxes for years, making the DTA line item on the balance sheet significant.
Example
A startup tech company reports $40 million in allowable deductions against $10 million in revenue in its first year, generating a $30 million NOL. No tax is owed in year 1. In year 3, the company earns $25 million in taxable income; it applies the $30 million NOL carryforward (limited to 80% = $20 million), reducing taxable income to $5 million. A deferred tax asset of $6.3 million (at 21%) was recognized in year 1 to reflect this future benefit.
Source: IRS — Net Operating Losses