Tax Loss Carry Forward Explained

How to Carry a Net Operating Loss From One Tax Year to Another

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A tax loss isn't necessarily all bad news. If you have a tax loss in one year, you might be able to use that loss to offset profits in future years, to minimize taxes for your business in those years. This technique is called a tax loss carry forward because it takes a tax loss in one year and carries it into a future year.

New Tax Law Eliminates Tax Loss Carryback

For tax years beginning in 2018, under the Tax Cuts and Jobs Act, the IRS says,

"Most taxpayers no longer have the option to carry back a net operating loss (NOL). For most taxpayers, NOLs arising in tax years ending after 2017 can only be carried forward. The 2-year carryback rule in effect before 2018, generally, does not apply to NOLs arising in tax years ending after December 31, 2017."

This article discusses the new limits on tax loss carryforward requirements and how businesses may carry forward tax losses to future years.

What is a Tax Loss?

A tax loss, otherwise known as a Net Operating Loss (NOL), is the opposite of a profit (net income). A business has a loss when expense deductions are greater than income. The word "operating" is key, because these losses must come from the business's regular operations.

Net operating losses are allowed for individuals, not businesses. The loss must be included on the business owner's personal tax return. For this reason, businesses can take an NOL if they are some types of pass-through businesses - sole proprietors or single-member LLCs, but not general partnerships, S corporations, or corporations. Individual partners or S corporation owners may claim their share of the loss on their personal tax return.

What is a Tax Loss Carry Forward?

A Tax Loss Carry Forward carries a tax loss from a business over to a future year of profit. For losses arising in taxable years beginning after Dec. 31, 2017, the net operating loss carryover is limited to 80 percent of taxable income (determined without regard to the deduction). 

In years before 2018, tax loss carryforwards could only be used for 20 years, but under the new tax law, tax losses may be carried forward indefinitely.

You may also be able to claim a tax loss against state income taxes. The amount and restrictions vary by state. Check with your state's tax department for details.

Who Can Use a Tax Loss Carry Forward?

Businesses can use these provisions against a net operating loss, capital losses in excess of capital gains, and certain gains from the sale or exchange of qualified small business stock.

Individual taxpayers may also use a tax loss carry forward for several different purposes. For example, if you have made excess contributions to a state's 529 plan (saving for education costs) you can't deduct the excess amount, but you may be able to carry the amount over to future years, subject to the 80 percent limit.

How to Claim a Tax Loss Carry Forward

Here's the general process for determining whether you want to take a tax loss carry forward.

  1. First, complete the tax return for your business type and make sure your business type allows the tax loss carryover provision.
  2. Then determine if you have a net operating loss. There is a (complicated) calculation used to determine an NOL. 
  3. If you have more in a net loss than the profit in one year, you may be able to carry over the unused NOL to the next carryforward year. Then you will need to apply the 80 percent limit.
  4. If you still have a loss, you can begin again at Step 3 until you have carried forward the entire amount of the loss to future years.

There are many rules and exceptions for claiming a tax loss carry forward. That's another reason for making sure you get the help of a tax professional for this process. IRS Publication 536 - Net Operating Losses (NOL's) for Individuals, Estates, and Trusts has more details on how to calculate a Net Operating Loss, how to apply the loss to your tax return, and how to carry it forward to future years.

Be sure to keep excellent records of all tax claims.

You should keep records for any tax year that generates an NOL for three years after the carry forward expires.

The information contained in this article is not tax or legal advice. Laws and tax regulations change, and there are many complicated restrictions and qualifications.