What Is a Loss Carryback?
A loss carryback describes a situation in which a business experiences a net operating loss (NOL) and chooses to apply that loss to a prior year’s tax return. This results in an immediate refund of taxes previously paid by reducing the tax liability for that previous year.
Key Takeaways
- Immediate Tax Relief: A net operating loss (NOL) carryback allows a firm to apply an NOL to a previous year’s tax return, resulting in an immediate refund.
- Future-Proofing: A tax loss carryforward, by contrast, applies a tax loss toward future years’ returns.
- Better Cash Flow: A carryback—with the resulting immediate tax refund—is typically more beneficial than a carryforward due to the time value of money.
- Changing Tax Provisions: NOL carryback provisions have been altered various times throughout history.
- Stay Updated: It is crucial to be aware of the current state of carryback tax provisions.
Understanding a Loss Carryback
Loss carrybacks are similar to loss carryforwards but apply net operating losses to preceding rather than subsequent years’ incomes. This approach generates a tax refund of prior taxes paid by the business for that previous year due to its newly reduced tax liability. Essentially, it will be as though the business had overpaid its taxes for that year.
A business of course decides how to apply a net operating loss (NOL) when it occurs. For instance, it can choose to waive the carryback period and only carry the loss forward. However, once a decision is made to carry the loss forward, it cannot be reversed.
An NOL carryback is typically more beneficial than a carryforward because the time value of money indicates that present tax savings are more valuable than future ones. Though, there could be instances when a carryforward makes more sense, such as when business tax rates are expected to rise significantly, this is not a common scenario.
Historically, tax provisions allowing NOLs to be carried back have ranged from zero to five years. During recessions, the length for carrybacks has been extended; at times, carrybacks have actually been omitted from the tax code, allowing only for carryforwards. Thus, understanding the specifics of current legislation is essential when considering a carryback.
History of Loss Carrybacks
The NOL carryback provision was initially introduced with the Revenue Act of 1918, designed initially as a short-term benefit for post-WWI businesses dealing with losses. The carryback and carryforward provisions originally lasted one year. The provision aimed to ease the tax burden for businesses with cyclical operating tendencies, common in sectors like agriculture, which are highly climate-dependent.
Over the years, the duration allowed for carryovers has been lengthened, shortened, omitted, and reinstated. Let’s delve into some significant changes in recent decades:
- The Tax Relief Act of 1997 limited the NOL carryback provision to two years, extending the carryforward to 20 years.
- In response to the World Trade Center attacks and the Great Recession, carrybacks were temporarily extended to three, four, or five years.
- The Tax Cuts and Jobs Act (TCJA) in 2017 eliminated the two-year carryback, retaining specific exceptions like certain farming losses and non-life insurance companies, and introduced an indefinite carryforward period with constraints.
- The 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act delayed TCJA changes, extending carrybacks to five years for taxable years post-Dec. 31, 2017, but pre-Jan. 1, 2021, also giving special provisions for certain businesses.
Real World Example
Tax-loss carrybacks resurfaced prominently in 2020 when the New York Times revealed details about President Trump’s 2009 tax return. According to the Times, starting in 2010, Trump claimed and received an income tax refund totaling $72.9 million. This was possible via an NOL carryback provision changed by the Worker, Homeownership, and Business Assistance Act of 2009, signed by President Obama. The 2009 tax law allowed for a five-year NOL carryback for 2008 and 2009, offering significant immediate tax relief to businesses impacted during these years.
Related Terms: NOL Carryforward, Tax Liability, Tax Refund, Time Value of Money.
References
- Internal Revenue Service. “Publication 536 (2021) Net Operating Losses (NOLs) for Individuals, Estates, and Trusts”.
- Pennsylvania Institute of Certified Public Accountants. “Net Operating Losses and the TCJA”.
- Internal Revenue Service. “Treasury Department and IRS Issue Guidance for Consolidated Groups Regarding Net Operating Losses”.
- New York Times. “Trump’s Taxes Show Chronic Losses and Years of Tax Avoidance”.
- U.S. Department of the Treasury. “Treasury Inspector General for Tax Administration Press Release: The IRS’s Implementation of the Five-Year Net Operating Loss Carryback Claim Provisions Was Generally Effective”.
- U.S. Congress. “Worker, Homeownership, and Business Assistance Act of 2009”, Pages 2992 - 2995.
