Net Operating Loss Carryforwards: How the 80% Limitation Works and When to Use NOLs Strategically

A net operating loss is one of the most valuable assets on a retail or CPG company's balance sheet. Most operators do not manage it with enough intentionality.

A net operating loss occurs when a business’s allowable deductions exceed its gross income for the tax year. Under current law as modified by the Tax Cuts and Jobs Act, NOLs generated in tax years beginning after December 31, 2017 can be carried forward indefinitely but are limited to offsetting 80% of taxable income in any single carryforward year. This 80% limitation means that a profitable retail or CPG business can never fully eliminate its federal income tax liability using an NOL carryforward alone. The remaining 20% of taxable income will always be subject to current-year tax, regardless of the size of the NOL carryforward available.

The pre-TCJA rules allowed NOLs to be carried back two years and forward 20 years with no percentage limitation. Those carryback provisions were largely eliminated for most businesses after 2017, though certain farming losses and insurance company losses retain carryback rights. For retail and CPG operators who generated large losses during the pandemic years, the CARES Act temporarily restored a five-year carryback for losses generated in tax years 2018 through 2020. Any business that generated losses in those years and did not evaluate the carryback opportunity should do so immediately, as amended returns to claim carryback refunds remain available within the applicable statute of limitations.

Chart: NOL carryforward utilization planning for a retail or CPG company with a $2 million NOL and projected taxable income over five years.

Strategic management of NOLs requires coordinating income and deduction timing to maximize the tax benefit of the carryforward. A business with a large NOL carryforward should consider whether to accelerate income recognition in years when the NOL can absorb it, since the alternative is paying tax in a future year when the NOL has been exhausted. Deferring deductions to years after the NOL is consumed often produces more after-tax value than taking those deductions while the NOL is still available to offset income. This counterintuitive dynamic is one of the most commonly missed planning opportunities in retail and CPG tax practice.

NOLs must also be tracked carefully in the context of business sales and acquisitions. Section 382 of the Internal Revenue Code imposes an annual limitation on the use of NOL carryforwards after a corporation undergoes an ownership change, defined as a more-than-50-percentage-point shift in ownership over any three-year period. The Section 382 limitation is calculated by multiplying the value of the company immediately before the ownership change by the federal long-term tax-exempt rate. For retail and CPG businesses with significant NOL carryforwards that are considering a capital raise, private equity investment, or acquisition, the Section 382 analysis must be performed before the transaction closes to understand whether the NOL will survive the change of ownership at full value.

Bottom Line: An NOL carryforward is a real financial asset that belongs on the balance sheet and in the financial model. The 80% limitation means it reduces but does not eliminate current tax. Managing when income is recognized relative to the available NOL is one of the highest-return tax planning activities available to a recovering or growing retail and CPG business.