Net operating loss mistakes with six-figure consequences

Net operating losses look simple on paper. A business loses money, the loss carries forward and it offsets income down the road. Then a client walks in with an NOL from 2018, a farming loss from 2025 and a Roth conversion question, and suddenly "simple" is the last word you'd use.

That's exactly what came up during a recent NATP webinar, and the questions tax professionals asked reveal just how many ways an NOL can trip up an otherwise clean return. Here's what you need to know.

The return you don’t have to file is the one you should file

Start with the client who technically doesn't owe the IRS a return this year. No income, no requirement, no problem, right? Not quite. There's no rule forcing an annual filing just to keep an NOL alive, but there's also no shortcut around proving it later. The taxpayer carries the burden of showing the original loss, how much got used along the way and what's left standing. Skip a few years of filings and you've skipped a few years of evidence.

A prepared-but-unfiled return, tucked into the workpapers, helps document the carryforward and keeps it defensible whenever life throws a curveball, an inheritance, a sale or a sudden good year, that finally puts it to use.

NOLs move on their own schedule, not yours

A handful of questions all circled the same misconception: that an NOL behaves predictably. It doesn't. Pair one with an installment sale reporting gain under §453, and the NOL doesn't arrive in one lump sum or wait around for the balloon payment. It offsets income year by year, right alongside the gain as it's recognized.

The 80% limitation trips people up the same way. That cap only bites in a year the NOL is actually usable, so if taxable income falls below the standard deduction, there's nothing to limit and the loss simply keeps rolling forward untouched. Farming losses add their own wrinkle; a 2025 farm NOL generally carries back to 2023 first, then 2024, unless the taxpayer timely elects to waive the carryback period. That two-year window won't stretch back to catch a client you only picked up in 2022.

Retirement contributions can build a loss you didn’t expect

Here's the one that catches practitioners off guard nearly every time. A SEP contribution, funded through the employee's individual SEP-IRA, is still the employer's deduction on the books. Nothing in §172 disqualifies a legitimate C corporation retirement contribution from generating an NOL, and nothing requires adding it back to test whether one exists. Deductible is deductible.

The IRS has a long memory, and so should your files

If an NOL was born in 2018 and it's still working in 2025, don't assume the statute of limitations put that origin year to rest. The IRS can examine the facts of a closed year to verify the loss that's feeding an open one, even though it generally cannot assess additional tax for the closed year. The recordkeeping clock never really stops ticking as long as the carryforward survives.

Entities close, NOLs don’t

An S corporation can shut its doors for good, but business loss items that passed through may continue as an individual NOL carryforward after applying the shareholder basis, at-risk, passive activity and excess business loss rules. Partnership-sourced losses carry the same expectation; keep the Form 1065 on file, because someday someone will ask where the number came from.

The final move nobody talks about

For an aging client sitting on an NOL that's otherwise destined to vanish at death, using it to absorb the income from a Roth conversion isn't a loophole, it's just good planning that too few advisors bring up in time.

NOLs don't retire. They wait, patiently, for the one year they'll matter most, and the practitioners who treat them like old news are the ones who end up explaining a gap to the IRS instead of a gain to their client. Keep the file. Keep the math. Let the loss do its job when its moment finally comes.