If you have a pile of deductions or your freelance career runs in the red, you may end up with negative taxable income on your 1040. Instead of allowing you to declare a negative income, the government lets you carry over the loss and take it off your income on another year's return. Normally, you subtract your net operating loss -- or NOL -- from your taxable income of two years ago, then from one year ago. If you still have a loss, you start carrying it forward. You can carry it up to 20 years before it expires as a deduction.
Figure the size of your net operating loss. Using IRS Form 1045, Schedule A, you take the negative result on your 1040 and subtract out various items such as personal exemptions and your standard deduction. Whatever remains when you finish is your NOL; if no red ink remains, you have nothing to carry over.
Subtract the NOL from the adjusted gross income on your two-year-old return. If any of your deductions that year were affected by your AGI -- for example, deductible medical expenses must be greater than 7.5 percent of your AGI -- recalculate them. Use Form 1045 to track your calculations.
Recalculate your taxable income for the year if any of your deductions have changed. Then subtract the NOL itself from your taxable income. Check the tax tables to see how much less tax you owe for the year.
Repeat the process for last year's tax return if some of your NOL is left over and still needs to be written off. You can use one Form 1045 to report both years' adjustments. Send the form in to the IRS within 12 months of filing your tax return for the year when you took the original NOL.
Record any of the NOL that you have left after applying it to the previous two years. List it as a negative figure on the Other Income line of next year's 1040. Attach a statement providing information about the NOL and detailing your calculations.
- Some net operating losses can be applied further back than two years. If you're a farmer, for instance, you can carry a loss back five years.
- You can waive the carryback option and apply your NOL to future returns only. To do this, you attach a statement to your 1040 for the year that generated the NOL saying you only want to carry it forward. Once you do this, the decision is irreversible.
- If it's more than a year since you reported the original net operation loss, file a 1040X to claim the carryback instead of a 1045.
- If you tied the knot or got divorced during the carryback period, this affects how much of the loss you can carry back. For example, if you're single now but you were married two years ago, you can only deduct the NOL from your personal income two years ago -- not your spouse's.