A tax loss carryforward (or carryover) is a provision that allows businesses or individuals to carry a tax loss from one year into future years to offset a portion of their taxable income. This can significantly reduce the tax liability in profitable years, creating financial stability and planning opportunities.
Key Takeaways:
- A tax loss carryforward lets taxpayers use a loss from one year to offset income in future years.
- Two types: net operating loss (NOL) carryforwards and capital loss carryforwards.
- Net operating loss carryforwards pertain to businesses.
- Capital loss carryforwards can apply to both businesses and individuals, with differing rules.
Maximizing Financial Strategy with Tax Loss Carryforwards
Net Operating Loss (NOL) Carryforwards
A net operating loss (NOL) occurs when a company’s allowable deductions exceed its taxable income for a particular tax year. The IRS allows the amount of the NOL to offset a company’s taxable income in future years through carryforwards.
Example
If a company experiences an NOL of $5 million in 2022 and earns $6 million in 2023, the carryforward limit for 2023 would be 80% of $6 million, or $4.8 million. This lowers the 2023 taxable income to $1.2 million. The remaining $200,000 NOL can be carried forward to offset future profits.
Capital Loss Carryforwards
Capital gains and losses arise from the sale of assets such as stocks, bonds, and real estate. The capital loss carryforward can help businesses and individuals offset gains in future years.
Example
Consider an individual who sold shares of stock at a $10,000 loss. If they also earned a $2,000 capital gain that year, they have an $8,000 net capital loss. They can deduct $3,000 of this in the current year, and carry the remaining $5,000 forward. The next year, they can offset another $3,000 and carry the last $2,000 forward.
Customized Tax Strategies
Net Operating Loss Carryforwards Before and After TCJA
Prior to the 2018 Tax Cuts and Jobs Act (TCJA), NOLs could be carried forward for 20 years. Post-TCJA, the carryforward period is indefinite but is capped at 80% of the net income of the following years. Certain exceptions still apply, especially for specified farming losses.
Is NOL Carryforward Applicable for State Taxes?
It depends. State laws on NOL carryforwards can vary widely—some align with federal rules, while others impose different limitations or criteria.
Tax Loss Harvesting: A Related Strategy
Tax loss harvesting involves selling investments to realize losses and offset gains or other income, reducing tax liability. However, beware of wash sale rules, which forbid purchasing a similar security within 30 days of the sale.
Conclusion
Though businesses and individuals aim for profits, one upside of losses is the ability to use them against future gains using carryforwards. Understanding how NOL and capital loss carryforwards work can lead to strategic tax planning, offering relief in challenging economic periods.
Related Terms: net operating loss, capital gains, tax relief, tax harvesting.
References
- Internal Revenue Service. “Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts”.
- Journal of Accountancy. “Carry Your Losses (Further) Forward”.
- Internal Revenue Service. “Publication 536: Net Operating Losses (NOLs) for Individuals, Estates, and Trusts”, Page 7.
- Internal Revenue Service. “Publication 542: Corporations”, Page 13.
- Jackson Hewitt. “Understanding Capital Gains and Losses”.
- Internal Revenue Service. “Publication 550: Investment Income and Expenses”, Page 66.
- FINRA. “Cost Basis Basics—Here’s What You Need to Know”.
- Internal Revenue Service. “Publication 551: Basis of Assets”, Page 10.
- Tax Foundation. “Net Operating Loss Carryforward”.
