A sole proprietor generates a net operating loss (NOL) for a tax year beginning after December 31, 2020. Under IRC Section 172, how may this NOL generally be used?
- The NOL may be carried back 2 years and forward 20 years, fully offsetting taxable income in each year it is applied
- The NOL generally cannot be carried back and instead carries forward indefinitely, but in any carryforward year it can offset no more than 80% of taxable income computed before the NOL deduction
- The NOL must be used entirely in the year it arises or it is permanently lost, since no carryforward or carryback is permitted under current law
- The NOL may only offset self-employment tax liability, not regular income tax liability, because it arose from a self-employment activity
Why B? And why not the others?
Correct answer: B. The NOL generally cannot be carried back and instead carries forward indefinitely, but in any carryforward year it can offset no more than 80% of taxable income computed before the NOL deduction
For NOLs arising in tax years beginning after December 31, 2020, IRC Section 172 generally eliminates the carryback (aside from a narrow farming-loss exception) and instead allows the loss to be carried forward indefinitely, but in any year it is used, the NOL deduction cannot offset more than 80% of taxable income for that year, computed without regard to the NOL deduction itself. The option describing a 2-year carryback, 20-year carryforward, and full offset in each year is wrong because that describes the pre-Tax Cuts and Jobs Act regime, which no longer generally applies to post-2020 NOLs. The option claiming the loss must be used entirely in the year it arises or is permanently lost is wrong because current law specifically permits an indefinite carryforward; the loss is not lost simply because it exceeds current-year income. The option limiting the NOL to offsetting only self-employment tax is wrong because the NOL deduction reduces regular taxable income for income tax purposes; self-employment tax is a separate tax computed on net earnings from self-employment and is not affected by an NOL deduction at all.
Source: 26 U.S.C. Section 172; IRS Instructions for Form 172 (2025)