What is net operating loss?

A net operating loss (NOL) occurs when tax deductions exceed taxable income, creating a loss that can be carried forward to offset future taxable income. For professional service firm owners, NOLs from business losses can reduce taxes in profitable years.

Key characteristics

• Deductions exceed income

• Carried forward to future years

• Offsets future taxable income

• 80% limitation in most cases

• Unlimited carryforward period

• Complex calculation rules

Why it matters for professional service firms

NOLs turn current-year losses into future tax savings. A loss year is not wasted if the NOL can offset future profits. Professional service firm owners experiencing losses should track NOLs carefully and plan to utilize them when profitability returns.

Real-world example

Patricia's consulting practice lost $45,000 in year one due to startup costs. NOL of $45,000 carried forward. Year two profit: $120,000. NOL deduction: $45,000 times 80% equals $36,000 (subject to 80% limitation). Taxable income reduced from $120,000 to $84,000, saving approximately $9,000 in taxes. Remaining $9,000 NOL carried to year three.