Net Operating Loss Carryforward

If a company has taxable income of −$50M in one year, it can't have negative taxes — instead it banks a $50M NOL. In a later profitable year with $80M of taxable income, it applies the NOL to reduce taxable income, lowering the cash taxes it owes. Under the U.S. Tax Cuts and Jobs Act (2017), NOLs generated after 2017 carry forward INDEFINITELY (no expiration) but can only offset up to 80% of taxable income in any single year — so some tax is always paid once profitable. The unused portion keeps rolling forward.

The future tax savings from an NOL are an asset, recorded as a deferred tax asset equal to the NOL balance times the tax rate. A company with $200M of NOLs at a 21% rate carries a ~$42M DTA. As the NOLs are used, the DTA draws down. If the company is unlikely to generate enough future income to use the NOLs, a valuation allowance reduces the DTA. Analysts add NOL-driven tax savings into DCF and LBO models because they directly increase free cash flow in early years.

When a company with NOLs undergoes an ownership change (an acquisition), IRC Section 382 caps how much of those NOLs the buyer can use each year. The annual limit roughly equals the target's equity value at the change date times the IRS long-term tax-exempt rate. This prevents profitable companies from buying loss-shells purely for tax benefits. In LBO and M&A models, you must haircut acquired NOLs by this Section 382 limit rather than assuming the full balance is immediately usable — a frequent interview and modeling trap.