What Is a Loss Carryback?
Let me explain what a loss carryback is. It's when your business has a net operating loss (NOL) and you decide to apply that loss to a tax return from a previous year. This move reduces the tax you owed back then, giving you an immediate refund on taxes you already paid.
Key Takeaways
- A net operating loss (NOL) carryback lets a firm apply a net operating loss to a previous year's tax return, resulting in an immediate refund of prior taxes paid.
- In contrast, a tax loss carryforward applies a tax loss to future years' returns.
- A carryback—and the immediate refund it provides—is usually more beneficial than a carryforward because of the time value of money.
- NOL carryback provisions in the tax code have been increased, decreased, omitted entirely, and reinstated various times over the years.
- You need to be aware of the current state of carryback tax provisions.
Understanding a Loss Carryback
Loss carrybacks are like loss carryforwards, but instead of applying your net operating losses to future incomes, you apply them to past years. This generates a tax refund from the taxes your business paid in that earlier year, effectively lowering your tax liability as if you'd overpaid.
When your business faces a net operating loss, you have choices on how to handle it. You could waive the carryback and just carry the loss forward, but remember, once you choose to carry it forward, you can't go back and change that decision.
Typically, an NOL carryback is more beneficial than a carryforward. The time value of money means that getting tax savings now is worth more than getting them later. There might be rare cases where a carryforward is better, like if tax rates jump significantly in the future, but that's not the usual situation.
Historically, tax provisions for NOL carrybacks have allowed anywhere from zero to five years. Because it's such a valuable tool for taxpayers, legislation often adjusts carrybacks. During recessions, the carryback period has been extended. At times, carrybacks have been removed entirely, leaving only carryforwards as an option. Make sure you check the current legislation when considering a carryback.
History of Loss Carrybacks
The NOL carryback provision for federal income taxes started with the Revenue Act of 1918. It was meant as a temporary help for companies losing money on war-related sales after World War I. Initially, both carryback and carryforward were limited to one year. The idea was to even out the tax burden for businesses with cyclical incomes that don't match a standard tax year, like agriculture, where weather can lead to a great year followed by a big loss.
Over the years, the durations for these carryovers have been extended, shortened, eliminated, and brought back. I'll focus on the major changes to the carryback provision in recent decades.
Be aware that some states have stricter rules on income percentages or time limits for carrybacks or carryforwards when it comes to state income taxes.
The Tax Relief Act of 1997 cut the NOL carryback to two years but stretched the carryforward to 20 years. Carrybacks were temporarily bumped up to three, four, or five years in response to the 9/11 attacks and the 2009 Great Recession.
The Tax Cuts and Jobs Act (TCJA) of 2017 got rid of the two-year carryback, except for certain farming losses and non-life insurance companies. It introduced an indefinite carryforward period, but limited carryforwards to 80% of each future year's net income. For exceptions, non-life insurance companies can carry back two years and forward 20 years without the 80% limit. Farming losses can be carried back two years and forward indefinitely, but with the 80% limit.
In 2020, the CARES Act delayed the TCJA changes until January 1, 2021. It also extended carrybacks to five years for taxable years starting after December 31, 2017, and before January 1, 2021, including NOLs from non-life insurance companies and farming losses.
Real World Example
Tax-loss carrybacks drew attention in September 2020 when the New York Times revealed details from President Trump's 2009 tax return. According to the article, starting in 2010, he claimed and received a $72.9 million income tax refund, covering all federal income taxes paid from 2005 through 2008, plus interest. This was due to an NOL carryback provision updated by the Worker, Homeownership, and Business Assistance Act of 2009, signed by President Obama.
That 2009 law allowed a five-year NOL carryback for tax years 2008 and 2009, instead of the previous two-year limit. This let NOLs from those years be applied to refunds from taxes paid in the five preceding years. If you chose to carry back to the fifth year, the NOL was limited to 50% of that year's taxable income, but the rest could be carried to the fourth year and so on until exhausted.
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