Net Operating Loss Practitioner Guide: OBBBA Carryforward Rules and Form 1045 Computation for Small Business Clients 2026

A client's small business had a bad year. Revenue fell, expenses ran high, and the Schedule C or K-1 shows a loss. The client wants to know if they get a refund of last year's taxes. Under the rules now in effect, for most clients the answer is no: the carryback is gone, the 80% limitation applies to every carryforward year, and the loss that did not offset income this year will wait in a carryforward schedule until there is enough future income to absorb it.

This guide covers the net operating loss computation for individual taxpayers with small business losses, the OBBBA's permanent changes to the carryback and carryforward rules (verify current law at IRS.gov; recently enacted), Form 1045 Schedule A, year-over-year carryforward tracking, entity-specific NOL issues for Schedule C, E, and F filers, the farming loss carryback exception, the interaction with QBI and Section 461(l), and how to explain the NOL to a client who does not understand why a current-year loss does not produce a refund.

What Creates an NOL: Entity Types, Loss Situations, and the Distinction from a Current-Year Deduction Limitation

A net operating loss arises when a taxpayer's allowable business deductions exceed their gross income in a given tax year, producing a negative tax result after adjustments. Not every current-year loss produces an NOL. The NOL computation under IRC 172 applies specific modifications to the taxpayer's gross income and deductions that can change a loss that appears large on the return into a smaller NOL, or into no NOL at all.

Entity types and return types that generate NOLs

For individual taxpayers, NOLs most commonly arise from: Schedule C (sole proprietor or single-member LLC) business losses; Schedule E pass-through losses from partnerships, S corporations, or rental real estate (subject to at-risk and passive activity rules); and Schedule F (farming) losses. Corporate NOLs are a separate topic governed by different carryback and carryforward rules and are not covered in this guide, which focuses on individual taxpayers with small business losses.

NOL vs. a current-year deduction limitation

A current-year loss that is disallowed by the at-risk rules (IRC 465), the passive activity loss rules (IRC 469), or the basis limitation rules for partnership or S-corp interests is not an NOL. It is a suspended loss that carries forward under those specific rules until the conditions for deductibility are met (additional at-risk investment, passive income, or additional basis). These suspended losses do not go through the NOL computation. Similarly, losses disallowed by the Section 461(l) excess business loss limitation (covered in Section 9 of this guide) are not directly NOLs; they are converted into NOL carryforwards by the operation of Section 461(l). Understanding which loss limitation applies to a given client's situation is the first step in determining whether an NOL actually exists.

When an NOL actually arises

After applying the at-risk, passive activity, and basis limitation rules, the remaining allowable losses flow to Form 1040 and reduce the taxpayer's adjusted gross income. If the sum of all income items (wages, interest, dividends, capital gains, business income, rental income) minus the sum of all allowable business and investment deductions produces a negative result -- after the IRC 172(d) modifications described in Section 3 of this guide -- the taxpayer has a net operating loss for the year. That NOL is the starting point for the carryforward schedule.

OBBBA NOL Rules: The Permanent 80% Limitation, Elimination of Most Carrybacks, and Indefinite Carryforward

The permanent 80% taxable income limitation

Under the OBBBA's permanent rule (verify at IRS.gov; recently enacted), an NOL deduction in any given carryforward year cannot exceed 80% of the taxpayer's taxable income for that year, calculated before the NOL deduction. This means that even in a year when the client has a large existing carryforward, the NOL deduction cannot reduce taxable income to zero. At minimum, 20% of taxable income remains taxable in any year an NOL is used. The unused portion of the NOL carries forward indefinitely and is available in future years, also subject to the 80% cap.

Elimination of the two-year carryback for most taxpayers

Prior to the TCJA, individual taxpayers with NOLs could carry the loss back two years and receive a refund of taxes paid in those prior years. The OBBBA permanently eliminated this two-year carryback for most taxpayers (verify at IRS.gov; recently enacted). For clients who experience a significant loss year, this means there is no mechanism to immediately monetize the loss through a refund of prior-year taxes. The loss must be carried forward and used in future years when the taxpayer has positive income. Farming NOLs are the primary exception; see Section 7 of this guide.

Indefinite carryforward

NOLs that cannot be fully used in the carryforward year (because the 80% limitation caps the deduction) carry forward indefinitely. There is no 20-year expiration limit that applied to pre-TCJA NOLs. The carryforward is permanent as long as the taxpayer continues to have taxable income to offset. This permanence makes accurate multi-year carryforward tracking even more important; an NOL from a particularly bad business year may take a decade to absorb fully, and the carryforward must survive every intervening year's return without error.

The NOL Calculation: Computing the Net Operating Loss from Adjusted Gross Income

The NOL is not simply the negative number on Line 11 of Form 1040. The IRC 172(d) modifications require adding back certain non-business deductions that were included in the Form 1040 calculation but are not allowed in the NOL computation. These modifications are worked through on Form 1045, Schedule A.

Step 1: Start with adjusted gross income (or AGI deficit)

Begin with the taxpayer's adjusted gross income as shown on Form 1040. If AGI is positive (the taxpayer has net positive income on the return), there is no NOL computation -- a positive AGI means the taxpayer did not have deductions in excess of income at the return level. The NOL computation begins only when the return reflects a loss situation (negative AGI or a loss that appears when the IRC 172(d) adjustments are applied).

Step 2: Apply IRC 172(d) modifications

The IRC 172(d) modifications add back certain amounts that reduced AGI on the return but are not allowed in the NOL computation. The primary modifications for individual taxpayers include:

• Capital losses in excess of capital gains: A taxpayer may have a net capital loss deducted on the return (up to $3,000 per year). This capital loss deduction is added back in the NOL computation because the NOL is designed to capture business losses, not capital losses. Capital losses have their own carryforward mechanism under IRC 1211 and are not included in the NOL.
• Non-business deductions in excess of non-business income: Personal deductions (such as itemized deductions for home mortgage interest, state taxes paid, and charitable contributions) are allowed in the NOL computation only to the extent they do not exceed non-business income. Excess personal deductions are added back.
• Standard deduction (for taxpayers who do not itemize): The standard deduction is added back in its entirety in the NOL computation, because the standard deduction is a personal deduction that does not reflect a business loss.
• NOL deduction from prior years: If the taxpayer used an NOL carryforward from a prior year to reduce their current-year taxable income, that prior-year NOL deduction is added back in computing the current-year NOL (to avoid double-counting).

Verify the complete list of IRC 172(d) modifications at IRS.gov before completing the NOL computation. The result after all modifications is the actual NOL for the year, which is the amount that enters the carryforward schedule.

Schedule A of Form 1045: Completing the NOL Computation Worksheet

Form 1045, Application for Tentative Refund (also used for NOL computation and carryforward tracking), includes Schedule A as the NOL computation worksheet. Even in years when there is no carryback claim (which is the case for most taxpayers under the OBBBA), Schedule A is the appropriate tool for computing and documenting the NOL amount. Obtain the current version of Form 1045 and its instructions at IRS.gov before completing it.

Line-by-line structure of Schedule A

Schedule A of Form 1045 begins with the taxpayer's adjusted gross income (or loss) and works through each IRC 172(d) modification in sequence. Each line adds back a specific item that is excluded from the NOL computation. The final line of Schedule A produces the NOL amount -- the figure that will enter the carryforward schedule. This is the authoritative NOL figure; do not use the negative AGI from Form 1040 directly without running it through Schedule A, because the IRC 172(d) modifications will typically reduce the NOL amount.

Common computational errors

• Using gross negative AGI as the NOL: The negative AGI figure from Form 1040 includes deductions (like the standard deduction and personal exemptions) that are not part of the NOL. Starting from gross negative AGI without applying the 172(d) modifications overstates the NOL.
• Failing to add back prior-year NOL deductions: If the taxpayer used an NOL carryforward in the current year, that deduction must be added back in computing the current-year NOL. Omitting this step double-counts prior-year NOLs.
• Including capital loss carryforwards as current-year losses: Capital loss carryforwards that appear on Schedule D must be distinguished from the current-year capital loss. Capital loss carryforwards are not current-year losses and should not be included in the NOL computation base.
• Omitting the Section 461(l) adjustment: If the taxpayer's business loss is limited by Section 461(l), the Section 461(l) limitation applies before the NOL computation. Compute Section 461(l) first, then compute the NOL on the remaining allowable business loss.

Carryforward Mechanics: Tracking, Ordering Rules, and the 80% Limitation in Each Future Year

The NOL carryforward schedule is a multi-year running record. Once an NOL is established for a given year, it must be accurately tracked on every subsequent return until it is fully absorbed. An error in the carryforward amount in one year propagates to every future year. Treating the carryforward schedule with the same rigor as a basis schedule is the correct professional standard.

How the carryforward is tracked year over year

The carryforward schedule shows: (1) the year in which each NOL arose; (2) the original amount of each NOL; (3) the amount of each NOL used in each subsequent year; and (4) the remaining carryforward balance for each NOL tranche. When a taxpayer has NOLs from multiple years, the schedule must track each year's NOL separately because the ordering rules (oldest first) control which carryforward is used in each year.

Ordering rules: oldest carryforward first

When a taxpayer has NOL carryforwards from multiple years, the carryforwards are applied in chronological order: the oldest NOL is used first. This rule exists to prevent taxpayers from selectively applying NOLs in a way that creates the most favorable tax outcome. Applying NOLs out of order is an error that can have downstream consequences for the accuracy of the carryforward schedule and for any future examination of the years when the NOLs were used.

How the 80% limitation applies each year

In each carryforward year, compute the 80% limitation separately: take the taxpayer's taxable income before the NOL deduction, multiply by 80%, and that is the maximum NOL deduction available for that year. Apply the oldest carryforward first, up to the 80% cap. If the oldest carryforward is fully absorbed within the 80% cap, apply the next oldest carryforward to the remaining capacity. If the 80% cap is hit before all carryforwards are absorbed, the remaining carryforwards carry forward to the next year unchanged (the ordering does not reset; the oldest unused carryforward remains oldest).

Annotating the return

Each year's return should include an attachment showing the carryforward schedule: the origin year of each NOL, the opening balance, the amount used in the current year, and the closing balance carried forward. This attachment creates a paper trail that survives preparer turnover and client transitions. It also positions the client for an accurate return in future years even if they change preparers.

Entity-Specific NOL Issues: Schedule C, Schedule E Pass-Throughs, and Schedule F

The entity type that generates a loss determines where the loss appears on the return and which upstream limitations apply before the NOL computation. The NOL computation itself is an individual-level calculation; it aggregates all income and loss items across all entity types. But the path from business loss to NOL differs by entity.

Schedule C sole proprietor NOL

A Schedule C sole proprietor with a loss presents the cleanest path to an NOL: the business loss flows directly to Form 1040 with no intervening entity-level return or basis limitation analysis. The Schedule C loss reduces self-employment income (which also affects self-employment tax) and reduces AGI. After the IRC 172(d) modifications, the Schedule C loss is the primary driver of the NOL for most independent ERO clients. Section 461(l) applies to Schedule C losses; see Section 9.

Schedule E partnership and S-corp losses: at-risk and basis limits

Pass-through losses from partnerships and S corporations flow to Schedule E but are subject to two upstream limitation layers before reaching the NOL computation: (1) the at-risk rules under IRC 465, which limit deductible losses to the amount the taxpayer has economically at risk in the entity, and (2) the basis limitation rules, which limit deductible losses to the taxpayer's outside basis in the entity. Losses disallowed by at-risk or basis limitations are suspended at the entity level and do not enter the NOL computation. Only the losses that pass through both limitation layers reach Form 1040 and become available for the NOL computation. Accurate at-risk and basis tracking is therefore a prerequisite for accurate NOL computation for Schedule E clients. See the S-corp reasonable compensation practitioner guide for the compensation and basis interaction that affects S-corp loss flow-through. See the business entity and S-corp formation guide for entity type selection and its impact on loss pass-through.

Schedule F farming losses

Schedule F farming losses flow directly to Form 1040 and are included in the NOL computation. Farming NOLs have a special treatment under the OBBBA: they retain the two-year carryback exception. See Section 7 of this guide for the farming NOL carryback procedure.

The Farming Loss Exception: Two-Year Carryback, the Carryback Election Out, and Form 1045 Procedure

The farming loss carryback is the one remaining mechanism by which an individual taxpayer can receive a refund of prior-year taxes through an NOL, absent special legislation. Under IRC 172(b)(1)(B) (verify continued availability after the OBBBA at IRS.gov), a farming NOL may be carried back two years, generating a refund of taxes paid in those years.

What qualifies as a farming NOL

A farming NOL is an NOL attributable to a farming business. The farming business definition under IRC 263A and related provisions applies. Not every client who reports Schedule F income operates a "farming business" in the sense required for the carryback exception. Clients who rent farmland without actively participating in the farming operation, or who have incidental farming activity alongside a primary non-farming business, may not qualify for the farming NOL carryback. Verify that the client's activity meets the farming business definition before advising on the carryback. Verify the OBBBA's treatment of farming NOLs at IRS.gov; recently enacted.

Electing out of the carryback

A farming taxpayer who has a carryback-eligible NOL can elect to forgo the carryback and carry the loss forward only. This election is irrevocable once made. Reasons to elect out of the carryback include: the carryback years had very low tax rates and the carryforward years are expected to have higher income (making the carryforward more valuable); the carryback years have issues that would be reopened by an amended return; or the client prefers the simplicity of the carryforward-only approach. The election out must be made by the due date (including extensions) of the return for the year of the loss.

The Form 1045 carryback claim procedure

A farming taxpayer claiming an NOL carryback (where available after OBBBA; verify at IRS.gov) files Form 1045 as a claim for a tentative refund. Form 1045 is not the same as Form 1040-X; it is a specific carryback claim form that the IRS processes on an expedited basis (typically within 90 days of the claim period). The Form 1045 package must include Schedule A (the NOL computation), Schedule B (the carryback computation for each year affected), and supporting documentation establishing the farming NOL amount and the farming business classification. File Form 1045 within the applicable deadline after the close of the loss year; verify the current filing deadline at IRS.gov.

QBI Interaction: How the NOL Carryforward Reduces the Qualified Business Income Deduction

The qualified business income (QBI) deduction under IRC 199A and the NOL carryforward operate on the same taxable income base, and they interact in ways that can produce unexpected results for clients with both a QBI deduction and an NOL carryforward. Practitioners must track both the NOL carryforward and the QBI carryforward separately and account for both in each carryforward year's return. For a detailed treatment of the QBI calculation, see the QBI deduction Section 199A practitioner calculation guide.

The interaction between NOL carryforwards and the Section 199A deduction requires careful sequencing; see our Section 199A / QBI Deduction: OBBBA Practitioner Guide for the full practitioner workflow under the OBBBA permanent extension.

How a current-year NOL reduces QBI

In a year when the client has a net operating loss, the qualified business income for that year is likely also negative (because the business loss that drove the NOL reduces qualified business income). A negative QBI in the current year is not simply ignored; under the IRC 199A calculation rules, a negative QBI carryforward reduces the QBI available for the deduction in the next year. This is a separate track from the NOL carryforward: the NOL carryforward is tracked under IRC 172, and the negative QBI carryforward is tracked under IRC 199A. Both must be maintained.

How a prior-year NOL carryforward reduces QBI in the carryforward year

When a prior-year NOL carryforward is used in the current year, it reduces the taxpayer's taxable income (before the QBI deduction). This reduction of taxable income reduces the QBI deduction's limitation base (which is calculated as a percentage of taxable income, among other inputs). The result is that using an NOL carryforward in a given year reduces the effective QBI deduction in that same year. The practitioner must calculate the NOL deduction first (up to the 80% cap), then compute the QBI deduction on the post-NOL taxable income to arrive at the correct QBI deduction amount. Reversing this order produces an incorrect result.

The Section 461(l) Excess Business Loss Limitation and Its Interaction with the NOL

Section 461(l) limits the amount of excess business losses that non-corporate taxpayers (individuals, trusts, and estates) can deduct in a given tax year. The OBBBA made this limitation permanent (verify at IRS.gov; recently enacted). Section 461(l) applies before the NOL computation; it is an upstream limitation that caps the business losses available to flow through to Form 1040.

How Section 461(l) works

An "excess business loss" under Section 461(l) is the amount by which the taxpayer's total business deductions (aggregated across all businesses, including pass-through entity losses) exceed the sum of: (1) the taxpayer's total business income (aggregated across all businesses), plus (2) the annual Section 461(l) threshold. The threshold is adjusted annually for inflation; verify the current year threshold at IRS.gov. Business losses up to the threshold are deductible in the current year (subject to at-risk, basis, and passive activity limitations). The excess over the threshold is disallowed in the current year and carried forward as an NOL for the subsequent tax year.

The Section 461(l)-to-NOL conversion

The disallowed excess business loss under Section 461(l) becomes an NOL carryforward for the following year. This is the conversion mechanism: the Section 461(l) limitation in Year 1 produces an NOL carryforward in Year 2. The carryforward is then subject to the 80% limitation when used in Year 2 and subsequent years. The practitioner must compute Section 461(l) on Form 461 before completing the NOL computation, because the Section 461(l) calculation changes the amount of business loss available for the NOL computation in the current year.

When Section 461(l) applies

Section 461(l) applies to non-corporate taxpayers with large aggregate business losses -- typically clients who have significant losses from one or more Schedule C businesses, combined with pass-through losses from partnerships or S corporations, that in aggregate exceed the annual threshold. For most independent ERO clients with a single small business loss, Section 461(l) is not a limiting factor because the loss is below the threshold. But for clients with multiple businesses, high-loss real estate pass-throughs, or large single-year business write-downs, Section 461(l) is a threshold check that must be performed before the NOL computation.

Client File Documentation: Carryforward Schedules, Return Annotation, and Multi-Year Records

The NOL carryforward schedule is a long-lived document. In cases where a client has a significant NOL that takes multiple years to absorb, the carryforward schedule may need to survive practitioner transitions, software migrations, and IRS examinations of multiple years. The documentation standards applied to the carryforward schedule must reflect this multi-year durability requirement. See also the IRA distribution and Form 8606 practitioner guide for parallel multi-year tracking documentation standards used for basis records.

What the carryforward schedule must contain

The carryforward schedule is a running table that must contain, for each NOL tranche: the tax year in which the NOL arose; the original NOL amount as computed on Form 1045 Schedule A for that year; each subsequent year in which the carryforward was used, the amount used, and the taxable income and 80% limitation calculation for that year; and the remaining unused carryforward balance after each use. The table must be updated every year the client files a return, whether or not the carryforward is used that year (if no income offsets the carryforward, the balance simply rolls forward unchanged).

Annotating the return to preserve the carryforward

Each year's return should include a statement attached to the return identifying any NOL carryforward being claimed, the year the NOL arose, the original amount, and the remaining balance after the current year's use. This statement is not mandatory under IRS regulations in all cases, but it is best practice and makes the return self-documenting. A future examiner reviewing a year in which an NOL was used will look for this statement; a return that uses an NOL carryforward without explaining its origin invites scrutiny.

What to include in the client's records

Provide the client with a copy of the carryforward schedule at the time of each return delivery. Instruct the client to retain all returns and supporting schedules for the full period the carryforward is outstanding plus the normal statute of limitations period applicable to each carryforward year. For a client with a significant NOL that may take 10 or more years to absorb, the records-retention obligation extends beyond the typical three-to-seven-year window.

Explaining the NOL to the Client: Why a Current-Year Loss Does Not Produce a Refund

The most common client misconception about the NOL is the expectation that a business loss in the current year will produce a refund of taxes paid in prior years. Under the OBBBA's carryforward-only rules (verify at IRS.gov; recently enacted), this is no longer how the system works for most clients. Explaining this clearly, without overpromising future tax savings, is a core practitioner communication task.

The conversation about no current-year refund

The starting point is the basic structural change: before the Tax Cuts and Jobs Act, a business loss in Year 3 could be carried back to Year 1 and Year 2, producing amended returns that generated refunds of taxes paid in those years. That mechanism no longer exists for most taxpayers under current law (verify current law at IRS.gov; recently enacted). The current-year loss does not produce a check from the IRS; it produces a carryforward entry that will reduce taxes in future years when the business has positive income.

Explaining how carryforward years will work

The carryforward is a future tax benefit, not a current-year cash payment. In a future year when the client has positive business income, the NOL carryforward will reduce their taxable income, reducing the tax due for that year. However, the 80% limitation means the carryforward cannot eliminate taxes entirely in any one year; the client will still owe tax on at least 20% of income in any year the carryforward is used. If the client's future income is consistently profitable, the carryforward will be absorbed over time. If the client has losses in subsequent years as well, the carryforward balance grows, not shrinks.

Setting expectations without overpromising

The practitioner should communicate the carryforward balance clearly, explain that it is a real tax asset that will reduce future taxes, but avoid framing it as a guaranteed future benefit. The carryforward is only as valuable as the client's future income: a client who never returns to profitability never uses the carryforward. Maintain appropriate hedging in all client communications about the future value of an NOL carryforward.

Amended Returns and NOL Corrections: Fixing an Incorrectly Computed or Omitted NOL Carryforward

NOL errors are discovered in several ways: a new practitioner picks up a client's return and notices that prior years show a business loss with no corresponding NOL carryforward schedule; the client produces old returns during an audit and the examiner identifies an unclaimed NOL; or the practitioner's own review of prior returns for a new client reveals a computation error. In all of these cases, the question is whether and how to correct the NOL.

The Form 1040-X path for NOL corrections

When an NOL was incorrectly computed (producing a smaller NOL than the correct amount) or entirely omitted in a prior year, the correction is made by filing Form 1040-X for the year in which the error occurred. The amended return must recompute the NOL using the correct IRC 172(d) modification procedure and Schedule A of Form 1045 to establish the correct NOL amount. If the corrected NOL was never used (because it was never established on the original return), the carryforward is established as of the year of the correction.

Statute of limitations considerations for NOL amendments

The three-year statute of limitations for filing a claim for refund (or a claim for a credit) also applies to NOL amendment claims. However, an NOL that was not used as a carryback (because most taxpayers no longer have a carryback available) but was simply computed incorrectly on the original return may be correctable through a carryforward amendment even when the original year is outside the refund claim period, because no refund is being claimed for the original year -- only the future carryforward is being corrected. The mechanics of this correction path depend on the specific facts. Consult the IRM and applicable Treasury regulations before advising a client on an out-of-statute NOL correction, and verify any time-limited filing requirements at IRS.gov before proceeding.

Frequently Asked Questions

Related Practitioner Guides

The following guides cover loss limitation rules that practitioners should consider alongside the NOL analysis.

• Loss Limitation Ordering Rules: IRC 465, 469, 461(l), and 172 Guide -- the NOL carryforward under IRC 172 is layer 5 in the five-layer loss limitation stack; the ordering guide places the NOL in context relative to the prior four limitations that a loss must survive before becoming an NOL.
• IRC 461(l) Excess Business Loss Limitation Guide -- excess business losses disallowed under IRC 461(l) are treated as NOL carryforwards under IRC 172; the two provisions are directly linked in the OBBBA permanent loss limitation framework.
• IRC 469 Passive Activity Loss Guide -- passive activity losses freed on full disposition of an interest under IRC 469(g) can flow through to become NOLs if they exceed current-year income; practitioners must understand the interaction between freed passive losses and the IRC 172 80% carryforward limitation.
• IRC 163(j) Business Interest Limitation Guide -- disallowed business interest expense carries forward under IRC 163(j)(2) as a separate carryforward (not an NOL); practitioners must distinguish between the IRC 163(j) interest carryforward and the IRC 172 NOL carryforward when advising clients with both types of suspended deductions.
• IRC 267 Related Party Loss Disallowance Guide -- IRC 267(a)(1) disallows losses on related party sales and reduces the available loss pool; the related party loss limitation is one of several loss limitation rules practitioners apply in sequence before determining the deductible NOL for the year.
• IRC 263A UNICAP Uniform Capitalization Rules Practitioner Guide -- a taxpayer newly exempt from UNICAP under the OBBBA-increased small business exception threshold must recognize the cumulative deferred IRC 263A costs previously capitalized into inventory as a Section 481(a) adjustment, generally spread over 4 tax years for a positive income adjustment under applicable Rev. Proc. guidance; the interaction of the Section 481(a) adjustment and the NOL carryforward rules requires analysis in the transition year.

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