Tax Loss Concept

• A tax loss is another way of saying that your taxable income is negative. Your taxable income is your adjusted gross income, minus allowable deductions. It is possible, but rare that the AGI itself will be negative, for example if a sole proprietor has business losses, or a very low earner has high medical or educational expenses. In this case taxable income is certain to be negative.
  
  

Net Operating Loss

• The net operating loss is the part of a negative taxable income that can be carried forward. It must be calculated using schedule A of form 1045. This leaves out several areas of income and deductions used in the original taxable income calculation and will usually be a different amount. It is possible that this calculation will produce a positive figure, meaning there is no net operating loss and thus nothing to carry forward. The details of the calculation means a net operating loss most commonly happens where the taxpayer is running a business as a sole proprietor, but has incurred losses rather than a profit.
  
  

Carry Back

• Before any loss can be carried forward, it is normally carried back. This means it is used to retrospectively reduce income for the previous tax year: if this reduces the tax liability, the person can claim a refund. If there is any loss remaining, it is then applied to the tax year before last. A taxpayer can waive the carry back process, though most will not do so as this usually means passing up an immediate refund.
  
  

Carry Forward

• Once the loss has been carried back two years or the carry back process waived, any remaining loss can be applied to future tax years. The remaining loss is applied to reduce taxable income each year until it has been fully used up. There is a time limit of 20 years to use up any loss, after which it is no longer considered for tax purposes.