When Your Business Loses Money: How Net Operating Losses Work for Freelancers

A bad year in your freelance business is painful. But there's a tax mechanism that turns those losses into future value: the net operating loss (NOL).

If your deductible business losses exceed your total income for the year, you may have an NOL that can be carried forward to reduce taxes in future profitable years. The IRS acknowledges that businesses have bad years and shouldn't be penalized in perpetuity for them.

What Creates an NOL

An NOL occurs when your allowable deductions exceed your gross income for the year. For freelancers, it looks something like:

• Freelance income: $31,500
• Business expenses: $45,000
• Net loss: ($15,750)
• Other income (interest, dividends, wages): $8,000
• AGI after the loss: ($7,000)

That ($7,000) is your potential NOL. It can be carried forward to offset future profitable years.

Not all losses create NOLs. The IRS excludes certain items from the calculation: capital loss deductions above capital gains, the deduction for excess business losses, and a few other adjustments.

The Excess Business Loss Limitation

Before your loss can become an NOL, it must survive the excess business loss limitation from Section 461(l). For 2025, non-corporate taxpayers can only deduct up to $313,000 in business losses (single filers) or $626,000 (married filing jointly) against non-business income in a single year.

Business losses above those thresholds become an NOL and carry forward rather than offsetting current-year non-business income.

For most freelancers, losses are far below these thresholds. The limitation mainly affects high-income business owners with large loss years.

How Carryforwards Work

Under current rules (post-2017 Tax Cuts and Jobs Act), NOLs can be carried forward indefinitely. The old carryback option was mostly eliminated for tax years after 2017 (with narrow exceptions for certain farming losses and some disaster situations).

The limitation: in any given year, you can only use an NOL to offset up to 80% of your taxable income. If you have a $50,000 NOL carryforward and $60,000 in taxable income next year, you can deduct $48,000 (80% of $60,000), leaving $12,000 in taxable income and a remaining $2,000 NOL carryforward.

The 80% limit means you can't completely zero out your taxes in a profitable year with a prior NOL. You'll always owe something on at least 20% of income.

Tracking Your NOL

The IRS doesn't send you an NOL balance statement. Tracking it is your responsibility.

When you have a loss year:

1. Calculate your NOL on Form 1045 Schedule A (for quick refunds) or by attaching a statement to your return.
2. Record the NOL amount and the year it was generated.
3. Track remaining carryforward amounts as you use portions in future years.

If you don't formally claim and document the NOL in the loss year, using it later becomes complicated. Keep records.

The Difference Between a Loss and an NOL

A common misconception: Schedule C showing a loss automatically creates an NOL. It doesn't.

Your Schedule C loss reduces your overall income. If other income (W-2 wages, investment income, spouse's income on a joint return) absorbs the loss and brings your total AGI above zero, you don't have an NOL. The loss was used in the current year.

An NOL only exists when your deductible losses exceed your total income from all sources combined, resulting in a negative AGI.

Why This Matters for Business Planning

If you're having a rough year and expect a significant loss:

Maximize legitimate deductions now. If you're going to have a loss year regardless, pull forward deductible expenses, max out retirement contributions, and capture every legitimate deduction. A dollar of loss in an NOL year doesn't help you this year, but it reduces taxes in every future profitable year until it's used up.

Don't manufacture losses. The hobby loss rules (Section 183) exist partly to prevent artificial losses. An NOL from a legitimate bad year is a valuable asset. An NOL from an activity the IRS reclassifies as a hobby is worthless, and you'll owe back taxes on the prior deductions.

Consider timing large expenses. If next year will be profitable but this year is a loss, there's an argument for pulling deductible expenses into the loss year to increase the NOL carryforward. If you expect this year's loss to be fully offset by future income anyway, the timing matters less.

The Silver Lining of a Rough Year

Nobody wants a bad business year. But the tax code acknowledges that volatility is real. An NOL carryforward is an asset: a future reduction in tax liability that you earned by surviving a difficult period.

When the good years return, that carryforward shows up as a genuine benefit.

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Sources

• IRC Section 172: Net Operating Loss Deduction - Statutory basis for NOL rules post-TCJA
• IRS Publication 536: Net Operating Losses - Complete NOL calculation and carryforward rules
• IRS Form 1045 Instructions - Quick refund application using NOL carryback
• CARES Act (P.L. 116-136) - Temporary 5-year carryback for 2018-2020 NOLs

Post-TCJA (2018+): NOLs can only be carried forward (no carryback), deductible up to 80% of taxable income per year. CARES Act temporarily allowed 5-year carryback for 2018-2020 losses.