What Is a Loss Carryforward?

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What Is a Loss Carryforward?

Let me explain what a loss carryforward really means for you as a business owner or investor. It's an accounting method where you take a net operating loss (NOL) from the current year and apply it to reduce your net income in future years, which directly cuts down your tax liability. For instance, if your company shows a negative net operating income in year one but turns positive in the following years, you can use that NOL to offset some or all of the loss against those future profits. This setup leads to lower taxable income when you're profitable, meaning you pay less in taxes to the government. Keep in mind, this can also apply to capital loss carryforwards in similar ways.

Key Rules for Loss Carryforwards

You need to know the rules that govern loss carryforwards, especially after recent changes. Before the Tax Cuts and Jobs Act (TCJA) in 2018, the IRS let businesses carry NOLs forward for 20 years to offset future profits or back two years for refunds on past taxes. But now, for tax years starting from January 1, 2018, the TCJA scrapped the two-year carryback except for farming losses and extended the carryforward indefinitely. However, you're limited to using only 80% of each future year's net income with these carryforwards. If your losses are from before 2018, they stick to the old rules and expire after 20 years. On your balance sheet, these NOL carryforwards appear as deferred tax assets, which you draw down each year—up to that 80% limit—until they're used up. This provision started with the Revenue Act of 1918 to help companies post-World War I, and it's evolved to support businesses with cyclical earnings that don't align with standard tax years.

How Businesses Can Use Loss Carryforwards Effectively

If you're running a business, using loss carryforwards smartly can make a real difference in your tax strategy. I recommend claiming them as soon as you can because losses aren't adjusted for inflation, so their value diminishes over time. Say you have a $100,000 loss this year; carrying it forward for 20 years means that amount buys less due to rising costs, so apply it early to maximize the benefit. This approach smooths out your tax burden, particularly if your operations are seasonal or cyclical.

Example of a Loss Carryforward

Here's a straightforward example to show you how this works in practice. Suppose your company loses $5 million in one year and then earns $6 million the next. The 80% carryover limit on the $6 million income is $4.8 million, so you can carry forward the full loss as a deferred tax asset on your balance sheet. In the second year, you use that $4.8 million as an expense on your income statement, dropping your taxable income to $1.2 million. That leaves a $200,000 deferred tax asset for future use.

Frequently Asked Questions

You might wonder how many years a loss can be carried forward—it's up to 20 years with an 80% limit on each year's net income, though post-2017 rules make it indefinite for new losses. As for how much loss you can write off, it's capped at 80% of the subsequent year's net income; for example, a $10 million loss followed by $12 million income lets you carry over $9.6 million, reducing taxable income to $2.4 million. The main difference between carryforward and carryback is that carryforward applies the loss to future income over 20 years to cut taxes ahead, while carryback applies it to past returns for an immediate refund.

The Bottom Line

In summary, if your business reports a loss in a given year, the carryforward provision lets you apply it to future net operating income over the next 20 years—or indefinitely under new rules—to lower your tax liability. This can significantly reduce what you owe if you turn profitable, but remember, it's best to use it sooner rather than later because inflation reduces the real value of the loss over time.

What Is a Loss Carryforward?

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