Tax Loss Carryback and Carry Forward Explained
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 either in past or future years, to minimize taxes for your business in those years. Business owners have several ways to minimize taxes - legally, of course.
This article explains the concept of tax loss carrybacks to previous tax years and carryforwards to future tax years. The focus in this article is on
How Can a Tax Loss Carry Back or Carry Forward Be Used?
One of them is a tax strategy of carrying business tax losses in one year backward to a previous profitable year or forward to future years which have a tax gain. This strategy is called, naturally, a tax loss carryback or carryforward, depending on which direction you choose to go.
A tax loss carryback is a provision that allows an individual or a business to use a net operating loss in one year to offset a profit in one or more previous years.
A tax loss carryforward works the same as a tax loss carryback, carrying the tax loss over to a future year of profit.
Losses used for these provisions must be net operating losses, not losses on investments.
You may also be able to claim a carry back or carry forward against state income taxes. The amount and restrictions vary by state. See this article by the Tax Foundation to find out more about state laws.
Who Can Use a Tax Loss Carry Back or Carry Forward?
Individual taxpayers may also use a tax loss carry forward for several different purposes, and they may be available from the IRS and from your state's taxing authority. For example, if you have made excess contributions to a state's 529 plan, you can't deduct the excess amount, but you may be able to carry the amount over to future years.
Ken Clark, Paying for College expert, has more details on some of the carry forward tax opportunities for non-business taxpayers to
How to Claim a Tax Carry Back or Carry Forward
Here's the general process for determining whether you want to take a tax loss carry back or carry forward.
- First, complete the tax return for your business type.
- Then determine if you have a net operating loss. If your tax deductions for a year are greater than your income, you might have a net operating loss. There is a (complicated) calculation used to determine a NOL.
- Then you will need to make the decision of whether to carry back the tax loss to a previous year or forward to a future year and claim the deduction.
- If you have more in net loss than the profit in one year, you can carry over the unused NOL to the next carry forward year or a previous year. Then you can begin again at Step 4 until you have carried forward (or carried back) the entire amount of the loss.
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.
Be sure to keep excellent records for all tax claims. The IRS says,
"You should keep records for any tax year that generates an NOL for 3 years after you have used the carry back/carry forward or 3 years after the carry forward expires."
DISCLAIMER This is a general description of tax loss carrybacks and carryforwards, and this article is not intended to be tax advice. Tax loss carrybacks and carryforwards are complicated than this. If you think you may be able to take a tax loss carry back or carry forward, talk to your tax professional, who can help you with the calculations and discuss the options.
For more information about net operating losses tax loss carry forward and carry back provisions, see IRS Publication 536: Net Operating Loss. (PDF)