What happens when my losses from my self-employment income exceed my income from wages?

Dear Merryjay,

When losses from your self-employment businesess exceed your W-2 income and all your allowable deductions, you would end up with NET OPERATING LOSSES (NOL's)!

These NOL's can be carried back to recover past taxes paid or carried forward!

The taxpayer needs to decide whether to carry the loss backwards (and claim a retroactive refund), or forward.

Net operating losses may generally be carried back for two years (or for three years, in the case of a casualty loss) before the year of the loss, which is called the NOL year. The loss is used to offset the taxable income of those previous years, for the earliest year first. Any unused portion of the loss may be carried forward for up to 20 years after the NOL year.

If this happens more than once, you are increasing your vulnerability to audit. Also, a business which fails to produce a profit for three consecutive years may be reclassified as a hobby. If that happens, you may face serious tax consequences.