A loss carryforward (also called an NOL carryforward when referring to net operating losses, or a capital loss carryforward for investment losses) is a tax and accounting technique that lets a business apply a current-year loss to reduce taxable income in future years. By carrying forward a loss, a company can lower future tax liability when it returns to profitability.
Key takeaways
– A loss carryforward reduces future taxable income by applying a prior-year loss against later profits.
– Under the Tax Cuts and Jobs Act (TCJA) rules for tax years beginning Jan. 1, 2018 and later, most NOLs can be carried forward indefinitely but are limited to offsetting up to 80% of taxable income in a future year.
– Losses originating before 2018 generally remain subject to the prior rules (20‑year carryforward, two‑year carryback where allowed). Temporary legislative changes (e.g., CARES Act) have modified carryback/use rules for specific years — consult current IRS guidance.
– NOL carryforwards are recorded as deferred tax assets (DTAs) on the balance sheet and may require a valuation allowance if realization is not likely.
– State tax treatment and other limits (such as change-of-ownership rules under IRC §382) can materially restrict use.
Rules for loss carryforwards (federal, summary)
– TCJA (for most NOLs arising in tax years beginning after Dec. 31, 2017): indefinite carryforward, but NOLs generally may offset at most 80% of taxable income in a given year. The two-year carryback was largely eliminated (with some exceptions such as certain farming losses).
– Losses originating from tax years before 2018 are governed by the previous rules (e.g., 20-year carryforward and potential two-year carryback).
– Congress sometimes enacts temporary changes (for example, the CARES Act in 2020 temporarily relaxed carryback and 80% limitations for certain years). Always check current IRS guidance for year-specific rules.
– States often have their own carryforward/carryback rules and limits that differ from federal rules.
How businesses use loss carryforwards
– Reduce future federal (and sometimes state) taxable income when business returns to profit.
– Improve cash flow indirectly by lowering future tax payments.
– Preserve the economic value of losses that cannot be offset in the year they occur.
– Record the future tax benefit as a deferred tax asset on the balance sheet, subject to realization assessment (valuation allowance).
Example (numbers)
– Year 1: Company has an NOL of $5,000,000.
– Year 2: Company has taxable income of $6,000,000. Under the 80% limit, the NOL carryforward can offset up to $4,800,000 (80% × $6,000,000).
– Result in Year 2: Taxable income after NOL = $6,000,000 − $4,800,000 = $1,200,000.
– Remaining NOL balance carried forward on the balance sheet = $5,000,000 − $4,800,000 = $200,000 (reported as a deferred tax asset until used or expired).
How many years can a loss be carried forward?
– For most NOLs arising in tax years beginning after Dec. 31, 2017: indefinite carryforward (subject to the 80% of taxable income annual limitation).
– For NOLs from tax years beginning before Jan. 1, 2018: the pre-TCJA rules typically apply (for many taxpayers that meant a 20-year carryforward and limited carryback).
– Note: Temporary laws (e.g., CARES Act) altered the carryback/carryforward rules for specific years; check current IRS rules and consult a tax advisor.
How much loss can you write off in a carryforward?
– Under current federal rules (post-TCJA, for most years), an NOL applied to a taxable year generally may reduce taxable income by up to 80% of that year’s taxable income. That means you cannot eliminate more than 80% of taxable income with an NOL in one year (subject to special rules and exceptions).
– Capital loss carryforwards (from sale of capital assets) generally have other, separate limitations (e.g., individuals can offset only $3,000 of net capital loss against ordinary income per year).
Difference between a loss carryforward and a carryback
– Carryforward: apply a loss to future taxable years to reduce future tax.
– Carryback: apply a loss to prior tax years (amend previous returns) to obtain an immediate refund of taxes previously paid. Carrybacks accelerate cash refunds but are limited by statutes and can be temporarily allowed or disallowed by legislation.
Accounting and financial statement treatment
– Record the future tax benefit of a recognized NOL as a deferred tax asset (DTA) on the balance sheet.
– Recognize a valuation allowance against the DTA if it is more likely than not that some portion of the DTA will not be realized (for example, when sustained future profitability is uncertain).
– Each year the DTA is drawn down as NOLs are used, up to the allowable amounts under tax rules.
Practical steps for businesses to manage and use loss carryforwards
1. Identify and quantify the loss:
• Prepare a correct NOL calculation per tax rules (NOL rules differ from book accounting). Include documentation and supporting tax computations.
2. Classify the loss by tax year and rule set:
• Determine whether the NOL arises pre-2018 or post-2017 (different rules can apply). Track special circumstances (farming losses, disaster relief, etc.).
3. Check temporary/retroactive law changes:
• Review current IRS guidance and legislative changes that might allow carrybacks or change usage limits (e.g., CARES Act did for certain years). Apply those year-specific provisions if applicable.
4. Evaluate state tax treatment:
• Confirm state carryforward and carryback rules (states often differ from federal rules and may have shorter expiration periods or different limitations).
5. Consider change-of-ownership limits (IRC §382):
• If you are contemplating an ownership change (e.g., sale, M&A, recapitalization), assess §382 limitations that can significantly restrict the use of pre‑change NOLs.
6. Record accounting entries correctly:
• Recognize a deferred tax asset corresponding to the tax benefit, and analyze the need for a valuation allowance. Update DTA balances annually as NOLs are used or circumstances change.
7. Use NOLs strategically and timely:
• Apply carryforwards as soon as you have sufficient taxable income since inflation reduces their real value over time and some rules limit how much can be used each year.
8. File returns and elections properly:
• Make required elections or amended returns for any allowable carrybacks. For carryforwards, ensure your tax return schedules and footnote disclosures reflect the carryforward balances and any valuation allowance.
9. Keep meticulous records:
• Maintain documentation of loss origin, tax-year classification, computations, and all uses of the carryforward so future tax returns and auditors can verify amounts.
10. Get professional advice:
• Due to complexity (federal vs state differences, accounting valuation allowance rules, M&A impact), consult a qualified tax advisor or CPA for planning, compliance, and financial reporting.
Common pitfalls and special considerations
– State rules: Some states limit or disallow federal NOLs; test state implications early.
– Section 382 (ownership changes): A change in ownership can dramatically reduce allowable annual NOL utilization. Evaluate before and after M&A transactions.
– Valuation allowances: If future profitability is uncertain, recognition of the DTA may be offset by a valuation allowance, reducing current-period benefit.
– Timing: Because losses are not inflation-indexed, their real value declines over time; deploying them sooner usually provides more benefit.
– Documentation: Poor records of NOL origin and adjustments can complicate later utilization and increase audit risk.
Bottom line
Loss carryforwards let businesses preserve tax benefits from a loss year to reduce taxes when future profits occur. Since rules have changed (TCJA made most NOLs indefinite but limited to offsetting 80% of taxable income; earlier losses may still be subject to older limits), and temporary legislative changes can apply to specific years, careful classification and planning are essential. Businesses should also account for state variations, potential M&A limitations (IRC §382), and proper financial statement recognition (deferred tax assets and valuation allowances). Always confirm the current law and consult a tax professional when planning to use carryforwards.
Sources and further reading
– Investopedia, “Loss Carryforward” (Ryan Oakley):
– Internal Revenue Service (IRS): see current guidance on net operating losses and Treasury/IRS notices regarding NOL treatment (IRS.gov).
– For corporate transactions and NOL limitation rules, see materials on IRC §382 (consult tax counsel).
(For specific tax-year rules or recent legislative changes after 2024, consult the IRS website or a tax professional — tax law can change and can include temporary exceptions to the general rules described above.)
Additional Considerations, Examples, Practical Steps, and Summary
Temporary Changes: CARES Act and Other Relief (brief history)
– CARES Act (2020): In response to the COVID-19 pandemic, Congress enacted the CARES Act, which temporarily relaxed NOL rules:
• NOLs arising in tax years 2018, 2019, and 2020 could be carried back up to five years (reviving a carryback option for those years).
• The CARES Act temporarily removed the TCJA’s 80% of taxable income limitation for tax years before 2021, allowing NOLs to fully offset (100%) taxable income for those years.
– Later developments returned many provisions to the TCJA baseline for subsequent years. Because these were temporary, it’s important to confirm the tax year in question and applicable law for that year.
– Source material: IRS guidance issued in response to these laws and Investopedia summaries of the legislative changes.
State Rules Can Differ
– Federal NOL rules and state NOL rules are not identical. Many states:
• Have different carryforward periods (some shorter than federal, some longer).
• May disallow carrybacks entirely or limit the amount that can be used in a given year.
• May calculate NOL differently (e.g., disallowing certain federal deductions).
– Practical implication: Even if a federal NOL is available, a company may still owe state taxes unless a state-level NOL is also usable. Always check state-specific guidance or consult a state tax specialist.
Accounting Treatment and Financial-Reporting Issues
– Deferred tax asset: NOL carryforwards are usually recognized as a deferred tax asset (DTA) on the balance sheet because they represent future tax savings.
– Valuation allowance (GAAP): If management cannot conclude it is “more likely than not” that some or all of the NOL will be realized (i.e., tax benefits will be used in the future), a valuation allowance must be recorded against the DTA. This reduces the net DTA and increases tax expense.
– Financial statement disclosure: Companies typically disclose the nature of their NOLs, expiration schedules, and valuation allowance rationale in the notes to the financial statements.
– Practical implications: Large NOLs can improve a company’s cash taxes in future profitable years, but uncertainty about future profits can limit the recognized benefit on the current balance sheet.
Corporate Ownership Changes and Section 382 Limits
– For C corporations, an “ownership change” pursuant to Internal Revenue Code Section 382 can substantially limit the amount of NOLs that can be used each year after the change.
– How it works (simplified): If more than a threshold percentage of a corporation’s stock changes hands within a three-year testing period, the company’s annual use of pre-change NOLs may be limited to a formula based on the value of the company at the time of the ownership change multiplied by a long-term tax-exempt rate.
– Practical result: After an ownership change (common in distressed-company acquisitions and some recapitalizations), much of a company’s NOLs can become unusable or only slowly usable over time. This is an important consideration in M&A and restructuring.
– Practical step: Before an ownership change, quantify potential Section 382 limits and structure transactions to preserve NOL value when possible.
Differences: Capital Loss Carryforwards vs. NOL Carryforwards
– Capital loss carryforward (individuals and corporations):
• Individuals: Capital losses in excess of capital gains can generally offset up to $3,000 ($1,500 married filing separately) of ordinary income per year; the excess carries forward indefinitely until used.
• Corporations: Capital losses generally can only be used against capital gains; unused corporate capital losses may carry back three years and forward five years (subject to current law).
– NOL carryforward (operating loss): Offsets ordinary income subject to the NOL rules discussed above (80% limitation for post-TCJA NOLs, indefinite carryforward for NOLs from 2018 and later, subject to limits).
– Practical implication: Treat capital loss carryforwards separately from operating NOLs; they follow different rules and utilization patterns.
Practical Steps for Businesses — How to Use and Manage Loss Carryforwards
1. Confirm the nature of the loss
• Determine whether the loss is an NOL (ordinary operating loss), a capital loss, or another type of tax attribute.
2. Determine the applicable tax year rules
• Identify the tax year the loss arose and confirm whether TCJA, CARES Act, or later laws affect that year’s treatment (carryback availability, carryforward period, 80% limit, etc.).
3. Track and document amounts precisely
• Maintain tax returns, schedules, loss-carryforward worksheets, and supporting documentation to substantiate the amount and timing of losses.
4. Record deferred tax assets properly
• Evaluate realizability and, if needed, record a valuation allowance under GAAP or relevant accounting standards.
5. Monitor ownership changes
• If an ownership change is possible, compute potential Section 382 limits and consider transaction structuring to preserve NOL value.
6. Coordinate federal and state filings
• Compute federal and state NOL positions separately and prepare for state-specific limitations or differences.
7. Consider timing of utilization
• Because NOLs are not inflation-adjusted and (for many years) are limited in use, it is often advantageous to use losses earlier rather than later when feasible.
8. Work with tax advisors
• Engage CPAs and tax counsel for complex situations (e.g., consolidated groups, international operations, M&A).
9. Consider provisional claims when amending returns
• If carrying back an NOL (when allowed), you may need to amend prior returns or file for a refund — follow IRS procedures carefully.
10. Plan for financial reporting
• Coordinate tax strategy with financial reporting to avoid surprises in deferred tax asset recognition and valuation allowances.
Examples
Example 1 — Straightforward NOL Carryforward Under TCJA 80% Limit
– Scenario: Company A has a $10,000,000 NOL arising in tax year 2019 (post-TCJA). In 2020 it has taxable income of $12,000,000.
– TCJA rule (post-2018): NOL carryforwards generally can offset only up to 80% of taxable income in a subsequent year.
– Calculation:
• 80% of 2020 income = 0.80 × $12,000,000 = $9,600,000
• Company A can use $9,600,000 of the NOL to reduce 2020 taxable income.
• Remaining NOL carried forward = $10,000,000 − $9,600,000 = $400,000
• 2020 taxable income after NOL = $12,000,000 − $9,600,000 = $2,400,000
– Note: If the NOL had arisen in 2018–2020 and CARES Act rules applied (depending on year and election), full offset or carrybacks might change the result.
Example 2 — NOL Carryback Under CARES Act (historical)
– Scenario: Company B had a $5,000,000 NOL in 2019. Under the CARES Act, it could carry it back up to five years.
– Practical effect: Company B could carry part or all of the 2019 NOL back to offset taxable income in prior profitable years and potentially claim refunds of taxes previously paid for those years.
– Note: This was temporary relief during the pandemic; check current law for availability.
Example 3 — Individual Capital Loss Carryforward
– Scenario: Individual taxpayer has $15,000 of capital losses in 2024 and no capital gains.
– U.S. rule for individuals: Up to $3,000 of net capital losses can offset other ordinary income per year.
– Calculation:
• 2024: Deduct $3,000; carry forward $12,000 to 2025.
• Repeat in subsequent years until the full loss is used (subject to annual $3,000 offset and potential future capital gains).
Example 4 — Section 382 Ownership-Change Limitation (simplified)
– Scenario: Corporation C had $20,000,000 of pre-change NOLs. An ownership change occurs, and Section 382 annual limitation is computed as the company value ($50,000,000) times a statutory rate (assume 4% for illustration) = $2,000,000 per year.
– Effect: Even though the company has $20,000,000 of NOLs, it can use only $2,000,000 of those pre-change NOLs to offset taxable income each year after the change, until the NOL pool is exhausted (barring other adjustments). This slows the realization of NOL benefits significantly.
Common Pitfalls and Things to Watch For
– Failing to track pre- and post-change NOLs separately when an ownership change is likely.
– Forgetting state-level limits or expirations.
– Not evaluating realizability of the deferred tax asset and the need for a valuation allowance.
– Missing deadlines to amend prior returns where a carryback is allowed and beneficial.
– Misclassifying losses (capital vs. ordinary) which changes how they can be used.
Checklist: What to Do When Your Business Has an NOL
– Step 1: Identify the source and tax year of the loss.
– Step 2: Confirm applicable federal law for that tax year (TCJA, CARES Act exceptions).
– Step 3: Check state rules for the same loss.
– Step 4: Prepare the carryforward schedule and deferred tax asset computation.
– Step 5: Evaluate valuation allowance necessity under GAAP.
– Step 6: Review potential Section 382 issues if ownership may change.
– Step 7: File any needed amended returns (if claiming a carryback is allowed and advantageous).
– Step 8: Engage tax advisors to model projections and tax cash flow impacts.
– Step 9: Revisit the plan annually as profits and tax law change.
Concluding Summary
Loss carryforwards (and capital loss carryforwards) are important tax attributes that allow businesses and individuals to smooth taxable income over time and reduce future tax liabilities. Since the Tax Cuts and Jobs Act (TCJA) and subsequent legislation (including the temporary CARES Act relief), rules about carrybacks, carryforwards, and annual limits (such as the 80% limitation) have changed and, at times, changed again. Businesses must track NOLs carefully, consider state differences, account for deferred tax assets and valuation allowances on financial statements, and be mindful of ownership changes that could limit usability under Section 382. Practical tax planning—ideally with a CPA or tax attorney—can maximize the value of loss carryforwards and avoid costly missteps.
For further reading and the legal and administrative details applicable to your situation, see:
– Investopedia: “Loss Carryforward” (source article)
– Internal Revenue Service guidance on net operating losses and related Treasury Department announcements