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Net Operating Loss Provisions:
State Treatment and the Economic
Benefits
Key Findings
• Well-designed Net Operating Loss (NOL) provisions benefit the economy by
smoothing business income, which mitigates entrepreneurial risk and helps
firms survive economic downturns.
• Forgoing tax revenue in the short term affords businesses the opportunity to
prioritize human and physical capital investment.
• Start-ups and industries with profits highly correlated to the business cycle
are often harmed by weak NOL provisions.
• NOL provisions promote tax neutrality by reducing additional tax burdens
on businesses with highly cyclical income streams or higher exposure to
economic downturns.
• The federal government allows NOL provisions to be carried forward
indefinitely, and to reduce tax liability by up to 80 percent in any given year.
Many states either conform to this provision or provide uncapped 20-year
carryforwards, but some are far stingier than the federal government. These
states should improve their treatment of NOLs to match or exceed federal
allowances.
FISCAL
FACT
No. 786
Jan. 2022
Timothy Vermeer Senior Policy Analyst

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Introduction
From the family automobile to the department store, much of the productivity and accessibility
known to today’s producers and consumers materialized because entrepreneurs like Henry Ford and
James Cash Penney took risks. Although more than a century may have passed since Henry Ford
premiered his Model T, our lives and our society are still transformed by private sector innovation,
and, ideally, the tax code should not stand in the way of that.
For almost every business, large or small, new or old, success (and profits) is realized in fits and starts.
It is common for nascent firms not to earn profits in the early years of their existence. That’s true of
manufacturers—whether creating the first mass market car or pioneering commercial space flight—as
well as today’s technology start-ups, and most companies in between. Companies whose successes
are highly correlated with the business cycle can see significant profits during good years, offset
by considerable losses during economic contractions (e.g., hotels, restaurants, resorts). Even well-
established firms can fall on hard times as they struggle to compete and innovate.
Unprofitability in the short run is no guarantee a business will fail in the long term, just as profitability
in the short term is no guarantee of long-term success. Some innovators require more runway than
others, but that should not in itself be reason for grounding. Determining viability is best left to the
marketplace where investors, businesses, and consumers efficiently allocate resources.
This is where net operating loss (NOL) provisions come in. By allowing businesses to use losses in one
year to offset taxable income in another year, they address the tax treatment of a business’ losses,
ensuring that taxes are on long-term profitability and reducing the tax code’s adverse impact on
economic growth. When lawmakers consider the principles of sound taxation—simplicity, stability,
neutrality, and transparency—they can provide better conditions for economic efficiency and job
creation.
Of all the forces that impact a company’s operations and decision-making processes, the tax
code should be the least disruptive—something best achieved through a neutral tax code. Well-
designed NOL provisions increase the tax code’s neutrality by ensuring that entrepreneurs are not
unnecessarily punished for taking risks and provide the latitude for innovation. Unfortunately, while
many states offer NOL provisions meeting or exceeding those offered by the federal government, a
minority of states are remarkably stingy, punishing companies with fluctuating profitability.1
This paper explains how NOL provisions work by addressing the role they play in promoting economic
growth and how they contribute to equity in taxation. The paper concludes by highlighting each
state’s approaches to NOL provisions and what changes they could make, if any, to improve in that
regard.
1
Those states are Alabama, Arkansas, California, Illinois, Michigan, Minnesota, Montana, New Hampshire, North Carolina, Oregon, Rhode Island, Tennessee,
and Vermont.

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Overview of Net Operating Losses
When a C corporation determines its federal taxable income for income tax purposes, it starts by
deducting business expenses (like supplies, wages, and rent), asset depreciation, and other costs
from its gross revenue. If the difference between revenue and all applicable deductions is positive,
the company earned a profit, and that corporate income is subject to tax. If the company has more
deductions than revenue, the firm operated at a loss and has no income to tax.
The average American would likely be surprised to learn how many landmark companies failed to
generate a profit even years after inception. FedEx, a company famous for becoming the world’s first
overnight shipping group, was founded in 1971. Despite initial enthusiasm surrounding its service,
the company proceeded to lose millions of dollars during its first five years of operations due to
unforeseen increases in fuel prices.2
Amazon became a publicly traded company in 1997,3 but lost $2.8 billion over the next four years.4
Uber, like FedEx and Amazon, also revolutionized service in its industry. However, despite its popular
appeal5 and massive revenues,6 Uber has not earned a profit since 2018.7 In fact, 2018 is the only year
Uber has ever reported a profit.8
Other entrepreneurial endeavors share these start-up woes. Turner Broadcasting System (which
founded CNN), ESPN, Tesla, Netflix, Airbnb, and Peloton all operated or are operating with significant
losses several years after their founding.
It is not just technology companies that record regular operating losses. Industries where revenues
are highly dependent on fluctuations in the business cycle, like hotels, restaurants, and leisure, can
close the year with losses despite making all the right decisions. The same is true for companies in
research-intensive industries. Pharmaceutical companies, for instance, may spend years investing
hundreds of millions of dollars developing and testing a new drug before completing a viable product
approved for public use. Energy companies, likewise, spend significant sums exploring potential
energy reserves and developing new extraction or storage technologies.
Firms focused on commodity industries are also prone to annual losses. Agribusinesses fall prey to
droughts and disease. Mining explorations may not pan out. Oil and natural gas fields may turn up dry
or prove too costly to extract at the market price.
2 Maggie Zhang, “The Founder Of FedEx Saved The Company From Bankruptcy With His Blackjack Winnings,” Business Insider, July 16, 2014, https://www.
businessinsider.com/fedex-saved-from-bankruptcy-with-blackjack-winnings-2014-7.
3
Saul Hansell, “TECHNOLOGY; A Surprise From Amazon: Its First Profit,” The New York Times, Jan. 23, 2002, https://www.nytimes.com/2002/01/23/
business/technology-a-surprise-from-amazon-its-first-profit.html.
4
Ibid.
5
In the second quarter (April-June) of 2021, Uber completed 1.5 billion trips. See Uber Investor, “Uber Announces Results for Second Quarter 2021,” Aug. 4,
2021, https://investor.uber.com/news-events/news/press-release-details/2021/Uber-Announces-Results-for-Second-Quarter-2021/.
6
Uber’s total revenue in 2019 was $14.147 billion and $11.139 billion in 2020. See Yahoo Finance, “Uber Technologies, Inc. (UBER), Income Statement,”
https://finance.yahoo.com/quote/UBER/financials/.
7
Ibid. Uber’s net income was -$8.506 billion in 2019 and -$6.768 billion in 2020.
8
Uber.com, “2019 Annual Report,” Uber.com. February 2020, https://s23.q4cdn.com/407969754/files/doc_financials/2019/ar/Uber-Technologies-Inc-
2019-Annual-Report.pdf.

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Federal Treatment of NOL Provisions
Under federal law, corporations are permitted to apply past or current losses to future tax liability
(carryforwards) with the caveat that the loss may not decrease any future year’s tax liability by
more than 80 percent. Businesses previously were allowed to apply losses to tax liabilities from
the two previous years (carrybacks) and receive a refund for the difference. The advantage of that
arrangement was the liquidity it provided a business that operated at a loss. Essentially, the business
was able to smooth its income across good years and bad years. Carrybacks were eliminated under
the Tax Cuts and Jobs Act (TCJA) of 2017, and the 80 percent cap introduced, in exchange for
eliminating the 20-year limit on number of years losses could be carried forward.9 While lifting the
20-year limit helps some businesses, overall, the change was intended as a revenue-raiser, paying for
other provisions of the TCJA, including the corporate tax rate reduction.
State Treatment of NOL Provisions
NOL provisions have been part of the federal tax code in varying degrees since 1918.10 When states
determine how to treat operating losses, they often use federal taxable income as the starting
point. As of 2021, 19 states11 and the District of Columbia conform to federal NOL provisions.12 By
conforming to the federal code, states mimic: 1) the annual loss deduction cap (losses carried forward
may not reduce current tax liability by more than 80 percent); 2) the unlimited number of years to
which losses can be carried forward; and 3) the prohibition against carrying losses back to offset
previous years’ tax liabilities.
Thirteen states do not conform to the federal provisions, because they limit carryforward years to 20
and impose no cap on loss deduction.13 In these states, businesses may use losses to offset up to 100
percent of the year’s tax liability for 20 years provided they have enough losses to carry forward.
Twelve states, however, restrict carryforwards below the 20-year threshold, sometimes well below.
Five states—Alabama, Minnesota, North Carolina, Oregon, and Tennessee—permit losses to be
carried forward for up to 15 years. Illinois allows unlimited losses for 12 years; Michigan, Montana,
New Hampshire, and Vermont 10 years; Arkansas for eight years; and Rhode Island for five years.
Additionally, two states set limits to the amount of loss a company can carry forward. Pennsylvania
limits a firm’s total carryforward amount to 40 percent of the given loss, deductible over a maximum
of 20 years. New Hampshire limits the carryforward amount to $10 million, deductible over a
maximum of 10 years. All told, this makes 13 states with NOL provisions substantially inferior to
those offered by the federal government.
9
Prior to the Tax Cuts and Jobs Act, losses were allowed to be carried forward for up to 20 years.
10 Mark P Keightley, “The Tax Treatment and Economics of Net Operating Losses,” Congressional Research Service, updated Oct. 19, 2020, https://crsreports.
congress.gov/product/pdf/R/R46377.
11 These states are Alaska, Colorado, Delaware, Florida, Georgia, Hawaii, Kansas, Kentucky, Maine, Maryland, New Mexico, North Dakota, Oklahoma, South
Carolina, South Dakota, Utah, Virginia, West Virginia, and Wyoming.
12 Jared Walczak and Janelle Cammenga, “2021 State Business Tax Climate Index,” Tax Foundation, October 21, 2020, https://www.taxfoundation.
org/2021-state-business-tax-climate-index/#Corporate/.
13 These states are Arizona, Connecticut, Idaho, Indiana, Iowa, Louisiana, Massachusetts, Mississippi, Missouri, Nebraska, New Jersey, New York, and
Wisconsin.

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TABLE 1.
State NOL Provisions
As of July 1, 2021
Federal Conformity
State Defined
Carryforward Years
State Defined
Carryforward Caps
Alabama
15
Alaska
Yes
Arizona
20
Arkansas
8
California
0
$0
Colorado
Yes
Connecticut
20
Delaware
Yes
Florida
Yes
Georgia
Yes
Hawaii
Yes
Idaho
20
Illinois
12
Indiana
20
Iowa
20
Kansas
Yes
Kentucky
Yes
Louisiana
20
Maine
Yes
Maryland
Yes
Massachusetts
20
Michigan
10
Minnesota
15
Mississippi
20
Missouri
20
Montana
10
Nebraska
20
New Hampshire
10
$10,000,000
New Jersey
20
New Mexico
Yes
New York
20
North Carolina
15
North Dakota
Yes
Oklahoma
Yes
Oregon
15
Pennsylvania
20
40%
Rhode Island
5
South Carolina
Yes
South Dakota
Yes
Tennessee
15
Utah
Yes
Vermont
10
Virginia
Yes
West Virginia
Yes
Wisconsin
20
Wyoming
Yes
District of Columbia
Yes
Source: Bloomberg Tax; state tax statutes and instructions.

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Five states, to their credit, continue to allow carrybacks, despite the removal of that component
from the federal code. Idaho permits up to $100,000 of losses to be carried back up to two years.
Mississippi and Missouri allow unlimited losses to offset up to two previous years of tax liability. New
York also allows unlimited losses to be carried back but extends the application to any tax liability in
the previous three years. Montana also uses a three-year carryback rule, but it only allows $500,000
of losses to be applied over that time.
At present, California has suspended its carryforward provisions for three years, a response to fears
of revenue losses due to the COVID-19 pandemic. While the state has instead posted extraordinary
surpluses, the NOL suspension has yet to be lifted. Additionally, because profitability is not a factor in
gross receipts taxation, NOL provisions do not exist in states which impose a gross receipts tax in lieu
of a corporate income tax (Nevada, Ohio, Texas, and Washington).
Why NOL Provisions Are Pro-Growth Policy
Smoothing business income over time is a better reflection of a company’s profitability. Imagine a
company (Business A) that loses $1.5 million this tax year but makes $1 million next year. Without
NOL provisions, Business A would not be taxed this year, but would have $1 million in taxable income
next year even though the company is still down $500,000 over a two-year period.
Structuring the tax code to focus on long-term average income is pro-growth policy, because it
affords businesses the opportunity to forgo taxation in the short term in order to promote longevity
and facilitate future growth. Shifting the focus to long-term net income gives businesses the
benefit of the doubt, permits productive risk-taking, and removes government from the equation of
businesses’ success.
The Stabilizing Effect of NOL Provisions
A system plagued by uncertainty complicates decision-making and sidelines investment. As
employers and shareholders hedge against cost increases and other changes that could harm
profitability and market demand, employment opportunities wane and wages plateau. The opposite
is also true: stability encourages spending and investment by setting conditions for predictable
employment. People are more likely to circulate money through the economy if they believe their
employment situation is stable. The greater the uncertainty, the more likely individuals are to save
their money—as we have seen during the pandemic.14 Minimizing uncertainty through stable policies
is also an important prerequisite to maximizing meaningful employment.15 In short, stability in tax
policy is one of the more important ways a government can promote better economic expansion.
In practice, stability looks like a predictable tax code that allows businesses to make long-term
investment and achieve hiring goals by leveraging well-structured NOL provisions. Governments can
promote stability in the marketplace and in the tax base by delaying receipt of corporate tax revenue
14 Rick Babson, “Study shows surge in savings during the pandemic,” Federal Reserve Bank of Kansas City, Apr. 29, 2021, https://www.kansascityfed.org/
ten/2021-spring-ten-magazine/study-shows-surge-in-savings-during-the-pandemic/.
15 This is also known as full employment. If an economy has reached full employment, output (gross domestic product, GDP) is maximized as a result of the
unemployment rate reaching the lowest level it can achieve without prompting inflation related to widespread wage spikes and labor competition. This is
also known as the non-accelerating inflation rate of unemployment (NAIRU).

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from firms that operate at a loss in a particular year. By doing this, businesses are given the leeway to
succeed or fail on their merits. Likewise, employees are not forced out of work prematurely because
an employer is forced to make a trade-off between payroll and tax compliance.
For employers, retention is preferable to layoffs, risking employees turning to competitors, or hiring
untrained workers. Employees prefer retention for purposes of income and insurance stability, skill to
job match, and self-worth. Taking a long-term approach to net income promotes economic stability
and is beneficial for all parties involved.
The Smoothing Effect of NOL Provisions
In addition to mitigating elements of risk, well-structured NOL provisions can help businesses bridge
economic downturns. Hospitality and other industries whose profits depend on disposable income
or business travelers often do best during periods of economic growth. However, when the economy
contracts and people have fewer dollars to spend on discretionary items and travel, these industries’
profits also recede. Without NOL provisions (both carryforwards and carrybacks), many more
businesses in the hospitality space may have had to shut down last year.
Long-term predictability is important for businesses whose profitability is positively correlated with
the business cycle. Decision-makers who do not know when the next recession will occur or how long
it will last are helped by knowing that heavier tax burdens during booms can be averaged out during
busts.
Long-term stability helps business owners, but it helps employees even more. By factoring NOL
provisions into long-term hiring and investment plans, businesses are able to retain workers for a
longer period. The smoothing effect of NOL provisions can make the difference between a business
laying off workers or keeping them on the payroll. This is good for families, neighborhoods, and
communities. It is also better for government to smooth tax receipts over the long run than to watch
the tax base erode due to bankruptcies or layoffs.
When a business fails during recession, it often takes significant time for another to replace it. It
takes even longer for employment levels to return to normal. Consider the last two recessions: the
COVID-19 recession and the Great Recession—the two largest since the Great Depression. According
to the Bureau of Labor Statistics, it took approximately six months for private sector establishments
to return to their pre-COVID-19 pandemic level.16 Private sector employment levels lagged much
further behind. As of October 2021, the United States economy was still 1.7 million jobs below its
pre-pandemic high in February 2020.17 Similarly, replacement of all private sector establishments lost
during the Great Recession, which officially ended June 2009,18 did not occur until the final months
16 Second Quarter 2020 saw net loss of 276,000 private business establishments. Net gains were recorded in Third and Fourth Quarter 2020 with 170,000
and 115,000 establishments added, respectively. An additional 146,000 private establishments were added in First Quarter 2021. See Bureau of Labor
Statistics, “Number of private sector establishments by direction of employment change, seasonally adjusted,” last updated Oct. 27, 2021, https://www.bls.
gov/web/cewbd/table5_1.txt.
17 Bureau of Labor Statistics, “Employment Situation Summary,” last updated Nov. 5, 2021, https://www.bls.gov/news.release/archives/empsit_11052021.
htm.
18 National Bureau of Economic Research, “US Business Cycle Expansions and Contractions,” last updated July 19, 2021, https://www.nber.org/research/data/
us-business-cycle-expansions-and-contractions.

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of 2013.19 Additionally, 7.9 million net private sector jobs were lost during the Great Recession.
Employment levels did not return to pre-recession levels until the second quarter of 2014.20 Barriers
to entry, including start-up costs, risk tolerance, and market volatility, are a few reasons for this. Of
course, not every bankruptcy will lead to massive destabilization, but the examples illustrate how
important a stable environment is for businesses and workers. When jobs and capital are lost, it can
take an extraordinary amount of effort to bring them back.
NOL Provisions Encourage a Diverse Tax Base by Leveling the
Playing Field
NOL provisions are also important to ensure fair tax codes and a diverse tax base. Consider the
following example of three businesses: a convenience store, a jewelry store, and a hardware store.
Each has a different business model, but all earn the same income over 10 years. All stores operate
in the same city and in a state that taxes business income at 5 percent and, hypothetically, does not
have a NOL provision in its tax code. For simplicity’s sake, our three examples are likely pass-through
businesses, which benefit from business loss provisions within the individual income tax.
Our example convenience store is well-established. Some people patronize the store for their daily
essentials while many others take advantage of low-priced discretionary goods. Many of the store’s
goods have relatively inelastic demand, meaning that most customers will continue buying the
same quantity of goods even as prices increase.21 The convenience store owner earns consistent, if
somewhat small, profits throughout all periods of the business cycle. After 10 years, he has earned
$500,000 in profits, and his effective tax rate is 5 percent.
The jewelry store in this example is also well-established. It sells a variety of luxury goods with prices
ranging from moderate to very expensive. As a result, the store’s profits correlate directly with the
business cycle. The owner earns large profits during periods of economic growth, but he struggles to
break even during economic recessions. After 10 years, the owner has earned $500,000 in profits,
and his effective tax rate is 7 percent.
The hardware store in our example is a relatively young establishment. It carries a wide range of tools,
equipment, and other home maintenance goods but can also supply lumber and other materials to
builders. Initially, the owner struggled to compete against well-known peers with loyal clientele. The
owner lost money her first two years in business but managed to break even the third year. Now
that the store is familiar to consumers, it has its own loyal customer base. The store does best during
periods of economic growth when new homes are being constructed. As home building slows during
recessions, the store does most of its business with homeowners looking to renovate or maintain
their existing home. Consequently, the store is still profitable during economic contractions, albeit
19 Approximately 204,000 establishments were lost during the Great Recession although additional losses occurred outside the official dates determined by
the NBER. See Bureau of Labor Statistics, “Number of private sector establishments.”
20 See Bureau of Labor Statistics, “Private sector gross job gains and job losses, seasonally adjusted,” last updated Oct 27, 2021, https://www.bls.gov/web/
cewbd/table1_1.txt.
21 Price elasticity relates the percentage change in quantity demanded to the percentage change in price. Elasticity is a function of a consumer’s willingness
to pay for a good or service which can be affected by such things as need, preference, or substitutability. If a good is price inelastic a 10 percent increase in
price would result in a less than 10 percent decrease in the quantity of goods purchased. A good is price elastic when a 10 percent increase in price results
in a greater than 10 percent decrease in the quantity of goods purchased. A good is unit elastic if a 10 percent increase in price would be met with a 10
percent decrease in the quantity of goods purchased.

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less so than during expansions. After 10 years, the owner has earned $500,000 in profits and her
effective tax rate is 8 percent.22
TABLE 2.
Effective Tax Rates Without NOL Provisions
Convenience Store
Jewelry Store
Hardware Store
Year
Profit
5% Tax
Year
Profit
5% Tax
Year
Profit
5% Tax
1
$50,000
$2,500
1
$50,000
$2,500
1
-$200,000
$0
2
$50,000
$2,500
2
-$25,000
$0
2
-$100,000
$0
3
$50,000
$2,500
3
$100,000
$5,000
3
$0
$0
4
$50,000
$2,500
4
$150,000
$7,500
4
$150,000
$7,500
5
$50,000
$2,500
5
$150,000
$7,500
5
$150,000
$7,500
6
$50,000
$2,500
6
$100,000
$5,000
6
$150,000
$7,500
7
$50,000
$2,500
7
-$100,000
$0
7
$50,000
$2,500
8
$50,000
$2,500
8
-$75,000
$0
8
$50,000
$2,500
9
$50,000
$2,500
9
$50,000
$2,500
9
$100,000
$5,000
10
$50,000
$2,500
10
$100,000
$5,000
10
$150,000
$7,500
Total
$500,000
$25,000
Total
$500,000
$35,000
Total
$500,000
$40,000
Effective Tax Rate
5%
Effective Tax Rate
7%
Effective Tax Rate
8%
Source: Author calculations.
Start-ups and industries with profits highly correlated to the business cycle are often harmed by the
absence of NOL provisions. That is depicted in the example above. Despite earning the same profit
over the course of 10 years, the jewelry and hardware store owners have effective tax rates that are
2 and 3 percentage points higher, respectively, than the convenience store owner. Moreover, the
absence of NOL provisions risks stopping businesses in their tracks before they get a chance to be
profitable. The hardware store has a tax liability of $7,500 in year 4 when it is still $150,000 from
breaking even.
Entrepreneurs consider the tax code when they evaluate starting a business, and many of their
decisions are made on the margin. Some people may start their company because they are
particularly skilled in a given trade or they want to strike out on their own. Many others make
decisions based on cost-benefit analyses. An entrepreneur may prefer to own a hardware store.
Perhaps that’s what his grandfather did, and it gives him a greater sense of satisfaction. But, if
hardware store start-up costs are high and the business model generates higher effective tax rates,
he may opt to invest his start-up funds in a convenience store with less overhead and lower effective
tax rates. Alternatively, he may even decide the reward is too small to invest anything and instead
remain employed by someone else. Moreover, innovators competing for start-up capital, or those
who cannot secure outside venture capital, may find a tax code with inadequate NOL provisions
particularly onerous.
22 A similar example was set up by Carol Portman, “Net Operating Losses in Illinois and Around the Country: Matching
Taxes to the Business Cycle,” Taxpayers’ Federation of Illinois, October 2021, https://www.illinoistax.org/index.php/
net-operating-losses-in-illinois-and-around-the-country-matching-taxes-to-the-business-cycle-carol-portman/.

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Sidelining investment is suboptimal for two reasons. First, it limits the economy. If an entrepreneur
decided to sit on her start-up funds instead of, say, investing them in a new hardware store, the
broader community suffers. New jobs are forgone; contractors and homeowners miss out on a
convenient supplier of building materials; and the owner’s upward mobility is restrained.
The second reason sidelining investment is inefficient is because it narrows the tax base, which can
result in a need to increase the tax rate. Absent new businesses, the objects or entities available for
taxation are limited. This effectively concentrates the tax burden on fewer taxpayers.
A broad and diverse tax base is important, because invariably certain industries or businesses will fall
on hard times. If governments become dependent on a few industries or commodities for funding,
revenue streams and services run the risk of disruption when inevitable recessions occur or when
goods and services become obsolete. As an example, several localities are struggling to replace
funding from taxing cable companies as consumers increasingly are cutting the cord.23 Diverse
tax bases are more likely to weather economic storms and changes to consumer behavior without
producing the kind of revenue volatility that could disrupt government services and public goods.
The final drawback to a narrow tax base is the risk of a high tax rate. Essential government services
must be funded. To fund these services tax rates on the limited number of taxpayers are necessarily
higher than they would be in a jurisdiction with a broad, diverse tax base.
A tax system with robust NOL provisions is a neutral, fairer tax system. Neutrality is one of the
foremost principles of a sound tax code. Without NOL provisions, the tax code can intentionally
or unintentionally favor one industry or class of business over another. Beyond the concerns of
horizontal inequity, industry-biased tax codes are also not in the best interest of governments.
Governments are best served by diverse, resilient tax bases facilitated through low barriers to entry
and equal treatment.
NOL provisions encourage growth and stability by mitigating risk to vulnerable businesses and by
contributing to similar businesses being treated equally by the tax code. In this way they adhere
to the policy principle of neutrality. By maintaining a neutral tax code—choosing neither winners
nor losers—governments also promote the efficient allocation of resources. The market allocates
resources to areas of optimal use when entrepreneurs succeed or fail on their merits—rather than as a
result of a non-neutral tax code.
Entrepreneurs are disincentivized from starting a business like the hardware or jewelry stores in the
example above if they know they will have to pay more in taxes. While a government may earn more
in the short term from limiting or excluding loss carryforwards, that short-run benefit comes with the
trade-off of long-term instability.
23 Ulrik Boesen, “Cutting the Cord from Cable Has States Courting New Revenue Streams,” Tax Foundation, July 19, 2021, https://www.taxfoundation.org/
streaming-services-tax/.

TAX FOUNDATION | 11
Contrast the impact of a NOL provision on the same three businesses from the previous example.
TABLE 3.
Effective Tax Rates with NOL Provisions
Convenience Store
Year
Profit or Loss
Available NOLs
Taxable Income NOL Carryforward
5% Tax
1
$50,000
$0
$0
$0
$2,500
2
$50,000
$0
$0
$0
$2,500
3
$50,000
$0
$0
$0
$2,500
4
$50,000
$0
$0
$0
$2,500
5
$50,000
$0
$0
$0
$2,500
6
$50,000
$0
$0
$0
$2,500
7
$50,000
$0
$0
$0
$2,500
8
$50,000
$0
$0
$0
$2,500
9
$50,000
$0
$0
$0
$2,500
10
$50,000
$0
$0
$0
$2,500
Total
$500,000
$25,000
Effective Tax Rate
5%
Jewelry Store
Year
Profit or Loss
Available NOLs
Taxable Income NOL Carryforward
Tax (5%)
1
$50,000
$0
$50,000
$0
$2,500
2
-$25,000
$0
-$25,000
-$25,000
$0
3
$100,000
-$25,000
$75,000
$0
$3,750
4
$150,000
$0
$150,000
$0
$7,500
5
$150,000
$0
$150,000
$0
$7,500
6
$100,000
$0
$100,000
$0
$5,000
7
-$100,000
-$100,000
-$100,000
-$100,000
$0
8
-$75,000
-$175,000
-$175,000
-$175,000
$0
9
$50,000
-$175,000
-$125,000
-$125,000
$0
10
$100,000
-$125,000
-$25,000
-$25,000
$0
Total
$500,000
$26,250
Effective Tax Rate
5.25%
Hardware Store
Year
Profit or Loss
Available NOLs
Taxable Income NOL Carryforward
Tax (5%)
1
-$200,000
$0
-$200,000
-$200,000
$0
2
-$100,000
-$200,000
-$300,000
-$300,000
$0
3
$0
-$300,000
-$300,000
-$300,000
$0
4
$150,000
-$300,000
-$150,000
-$150,000
$0
5
$150,000
-$150,000
$0
$0
$0
6
$150,000
$0
$150,000
$0
$7,500
7
$50,000
$0
$50,000
$0
$2,500
8
$50,000
$0
$50,000
$0
$2,500
9
$100,000
$0
$100,000
$0
$5,000
10
$150,000
$0
$150,000
$0
$7,500
Total
$500,000
$25,000
Effective Tax Rate
5%
Source: Author calculations.

TAX FOUNDATION | 12
Conclusion
To encourage responsible entrepreneurial risk-taking and set conditions for economic growth and
innovation, states should consider broadening their NOL provisions. California should immediately
reinstate its NOL provisions. Additionally, states that limit NOL provisions should, at a minimum,
conform to the federal system, which has the added advantage of simplicity through its reliance on
federal definitions and calculations.
Alternatively, states which choose not to conform to federal provisions should use the legacy federal
limit of 20 years of uncapped carryforwards. An indefinite carryforward period is ideal, because it
provides maximum flexibility to businesses. The best NOL policy would also permit unlimited losses
to be carried forward. Even relatively limited tax liability (as would result from an 80 percent cap on
loss carryforwards) unnecessarily constrains firms’ investment decisions after emerging from what
could be years of losses.
Loss carrybacks, while not presently part of the federal code, can be helpful provisions for smoothing
income and should be considered at the state level. Some may argue that these allowances are a form
of corporate welfare, but that critique is misplaced. Loss carrybacks are not a handout. The benefit of
a carryback is unique to each individual firm and is limited to the interaction between a business’ tax
liability and its previous losses.
History is replete with examples of how people are better off—throughout the world—when
marketplaces rather than governments are allowed to allocate resources and drive human flourishing.
A long-term view of income facilitated by NOL provisions help make that process efficient, and they
just might provide the spark that ignites the next century of innovation and growth.