This AIM Financial tax-form blog is IRS Form 172: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts. This form helps eligible taxpayers calculate a net operating loss, determine how it may be used, and track eligible loss carryovers to other tax years. It is especially relevant for people and businesses experiencing a difficult financial year.

From AIM Financial | Grand Rapids, Kentwood, Wyoming, and West Michigan

What Is IRS Form 172?

When a business or taxpayer experiences a financial loss, the tax consequences can extend beyond the current year. In some situations, a loss may be used to reduce taxable income in another tax year. The IRS uses Form 172, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, to help eligible taxpayers calculate and track these losses.

A net operating loss, commonly called an NOL, may occur when qualifying tax deductions exceed income under the applicable tax rules. However, not every financial loss qualifies, and special calculations determine the amount that can be used.

For individuals, business owners, estates, and trusts in Grand Rapids and throughout West Michigan, understanding NOL rules can be important when preparing a tax return after a difficult financial year.

What Is a Net Operating Loss?

A net operating loss generally arises when certain allowable deductions exceed income for tax purposes. A loss from operating a business is one of the most common reasons an NOL may occur.

Other circumstances can potentially contribute to an NOL, depending on the applicable rules. These may include qualifying rental property losses or certain casualty and theft losses resulting from a federally declared disaster.

For example, imagine a self-employed business owner has a year with substantially lower revenue than expected while continuing to pay qualifying business expenses. After applying the tax rules and limitations, the owner may have a net operating loss.

This does not automatically mean that every expense or the entire financial loss can be carried to another year. The IRS requires specific adjustments when calculating an NOL.

Who Uses IRS Form 172?

Form 172 is designed for taxpayers other than corporations, including:

• Individuals: Taxpayers who may have an NOL from an eligible business or other qualifying activity.
• Estates: Estates that need to calculate and track qualifying net operating losses.
• Trusts: Trusts that have an NOL under the applicable federal tax rules.

Partnerships and S corporations generally do not claim an NOL at the entity level in the same manner as individuals. Instead, eligible partners or shareholders may need to determine their own tax consequences from their shares of business income and deductions.

Form 172 is not the same as a business financial statement. It applies federal tax rules to determine the amount of an NOL that may be available for carryback or carryforward treatment.

How Do You Calculate an NOL?

The calculation begins with the taxpayer’s tax return for the year in which the loss occurred. The taxpayer then applies the specific NOL rules, including adjustments for deductions that cannot be included in the calculation.

Some items generally cannot be used to create or increase an NOL. These include:

• Capital losses exceeding capital gains.
• Certain nonbusiness deductions exceeding nonbusiness income.
• The NOL deduction itself.
• The qualified business income deduction.

Other limitations may apply, including excess business loss rules. As a result, the amount shown as a business loss on a financial statement or Schedule C may differ from the NOL amount allowed under federal tax law.

Careful calculations and complete records are important because the NOL amount may affect tax returns in later years.

Can You Carry an NOL Back to a Previous Tax Year?

For most NOLs arising in tax years beginning after December 31, 2020, the general rule is that the loss is carried forward rather than carried back to an earlier year.

There is an important exception for certain farming losses, which may qualify for a two-year carryback. Special rules and limitations apply.

For an eligible carryback, taxpayers may be able to use Form 1045 or an amended return, such as Form 1040-X for an individual. Estates and trusts generally use amended Form 1041 returns when applying a carryback, unless another permitted procedure applies.

The rules depend on the year the loss occurred, the type of loss, and the taxpayer’s circumstances. Taxpayers should not assume that a loss from a current year can automatically generate a refund for a prior year.

How Does an NOL Carryforward Work?

When a qualifying NOL cannot be fully used in the applicable year, the unused amount may generally be carried forward to future tax years.

For example, suppose a taxpayer has an eligible NOL of $40,000. If the taxpayer can use only part of that amount under the applicable rules, the remaining eligible loss may be available for a later year.

For most NOLs arising after 2017, the deduction in a later year is generally limited to 80% of taxable income calculated under the applicable rules. NOLs from tax years beginning before 2018 are subject to different rules.

An NOL carryforward can be valuable, but it must be tracked carefully. Taxpayers need to determine how much of each loss has already been used and how much remains available.

What Records Should You Keep?

Taxpayers who experience a potential NOL should retain records that support both the original loss and any future deductions.

Useful documents may include:

• Prior-year federal income tax returns.
• Profit-and-loss statements and business expense records.
• Forms Schedule C, Schedule F, and relevant Schedule E information.
• Records of capital gains and losses.
• Prior NOL calculations and carryforward schedules.
• Records supporting deductions and any adjustments required by the IRS.

The IRS instructs taxpayers to keep NOL records for three years after the carryback or carryforward has been used, or three years after the carryforward expires, as applicable. Keeping organized records can make future tax preparation easier.

Common NOL Tax Preparation Mistakes

Taxpayers can make costly mistakes by assuming that every business loss qualifies as an NOL, overlooking restrictions on deductions, failing to track prior-year losses, or using an outdated carryforward amount.

Another common problem is overlooking the difference between the NOL calculation and the amount that can actually be deducted in a later year. The rules can be especially complicated when a taxpayer has multiple loss years, changes filing status, or operates a business through a partnership or S corporation.

Professional review can help identify the correct calculation and reporting method.

How AIM Financial Can Help

If you experienced a business loss, rental property loss, or another financial setback, it may be worth reviewing whether the loss has tax implications beyond the current year.

AIM Financial helps individuals and business owners in Grand Rapids, Kentwood, Wyoming, and throughout West Michigan with tax preparation and tax reporting questions. We can help you organize financial records, review prior-year tax information, and identify whether net operating loss rules may apply to your circumstances.

Contact AIM Financial when preparing a return involving business losses or unused NOL carryforwards. Bringing prior-year returns, business records, and previous loss calculations can help make the review more complete.

For official information, visit the IRS pages for Form 172 and the Instructions for Form 172.

This article is for general educational purposes only and is not individualized tax advice. Net operating loss rules are complex, and eligibility, deduction limits, and carryover treatment depend on the taxpayer’s specific circumstances and the applicable tax year.