Loss carryover, also known as Net Operating Loss (NOL) carryover, is a tax provision that allows businesses to apply a net operating loss to future tax periods, thereby reducing taxable income in those periods. This mechanism helps companies stabilize their tax liabilities over time, particularly during periods of fluctuating profits and losses.
Types of Loss Carryover
Carryforward
A loss carryforward allows a business to apply its net operating loss to future taxable years. The loss can typically be carried forward for up to 20 years under U.S. tax laws, helping offset future taxable income.
Carryback
A loss carryback permits a business to apply its net operating loss to previous tax years, usually up to two years back. This provision enables businesses to adjust past tax returns, potentially leading to tax refunds for those years.
Historical Context
The concept of loss carryover has been embedded in tax legislation for many decades. It was designed to provide businesses with a means to achieve tax relief during times of financial downturns. The U.S. Internal Revenue Code, particularly under the Tax Cuts and Jobs Act of 2017, revised many rules regarding NOL carryovers, including eliminating the carryback period for most businesses and limiting NOL deductions to 80% of taxable income.
Practical Examples
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Example 1: Carryforward
- A business incurs a net operating loss of $100,000 in 2021. In 2022, it earns a taxable income of $150,000. Using the carryforward provision, the business can apply the $100,000 loss to the $150,000 income, thereby reducing its 2022 taxable income to $50,000.
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Example 2: Carryback
- A business incurs a net operating loss of $50,000 in 2021. In 2022, it files an amended return for 2020 when it had a taxable income of $70,000. Applying the carryback, the business can claim a tax refund on the $50,000 adjusted income for 2020.
Comparisons
- NOL Carryover vs. Tax Credits:
- While an NOL carryover reduces taxable income, tax credits directly reduce the tax owed. Both mechanisms offer substantial benefits but operate differently within the tax codes.
Related Terms
- Tax Deduction: Reduces the taxable income rather than the tax owed.
- Tax Credit: Directly reduces the amount of tax owed.
- Depreciation: Allocation of the cost of an asset over its useful life.
FAQs
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Can individual taxpayers use NOL carryovers?
- Yes, individuals can use NOL carryovers, subject to specific regulations.
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How do NOL changes under the Tax Cuts and Jobs Act of 2017 affect businesses?
- The Act limits the carryforward to 80% of taxable income and removes most carrybacks.
References
- IRS Publication 536, “Net Operating Losses (NOLs) for Individuals, Estates, and Trusts”
- Tax Cuts and Jobs Act of 2017
- GAAP guidelines on accounting for income taxes
Summary
Loss carryover is a crucial tax strategy for businesses dealing with fluctuating profits. By understanding the nuances of carryforward and carryback provisions, companies can effectively manage their tax liabilities and financial planning. The legislative evolutions, particularly under the Tax Cuts and Jobs Act, have modernized the approach to NOL, emphasizing the need for business owners and tax professionals to stay informed of current rules and regulations.
