Loading the player...

What is a 'Loss Carryforward'

Loss carryforward refers to an accounting technique that applies the current year's net operating losses to future years' profits to reduce tax liability and track profits accurately. Generally accepted accounting principles (GAAP) specify that loss carryforwards can be used in any one of the seven years following the loss, but tax collection agencies allow varying amounts of time for loss carryforwards depending on the tax entity, the type of loss and other factors.

BREAKING DOWN 'Loss Carryforward'

For example, if a company experiences negative net operating income (NOI) in year one but positive NOI in one of the next few years, it can reduce its future profits on paper using a loss carryforward. Imagine a company lost $5 million one year and earned $6 million the next. Including the previous year's loss on its current balance sheets lowers the profits for that year to $1 million, a more accurate assessment of the company's overall state.

Loss Carryforward and the Internal Revenue Service

In addition to using loss carryforwards on their balance sheets, companies can also use them to reduce their tax expense. The Internal Revenue Service (IRS) allows businesses to carry net operating losses (NOL) forward 20 years. At that point, the losses expire. Individuals with capital losses can only claim up to $3,000 in capital losses against their income, but if they have losses greater than this amount, they may carry them forward to future years. For example, if an individual has $9,000 in capital losses, he may claim $3,000 the current tax year, $3,000 the following year and the final $3,000 the year after that.

Loss Carryforward vs. Loss Carryback

Loss carryback works the same way as loss carryforward. Essentially, the taxpayer applies losses from one year against gains or profits from another year. However, loss carrybacks are applied to past years' earnings, while carryforwards apply to future years' earnings.

The IRS also allows businesses and individuals to carry losses back against previous years' earnings to retroactively reduce their tax liabilities for those years, but the agency has different carryback rules for different types of losses. For example, most losses, including personal capital gains losses, can be carried back for only two years, but farm losses can be carried back for five years. Similarly, specified liability losses can be carried back for 10 years. In most cases, to carry forward a loss, the tax filer must waive his right to carry back the loss.

Using Loss Carryforwards Effectively

To use loss carryforwards effectively, businesses should claim them as soon as possible. The losses are not indexed with inflation, and as a result, each year the claim effectively becomes smaller. For example, if a business loses $100,000 in 2010, it may carry the loss forward for the next 20 years. If it claims the loss in 2011, it is likely to have a larger impact than claiming it in 2030. Presumably, by 2030, $100,000 will have less buying power and less real value compared to previous years.

RELATED TERMS
  1. Tax Loss Carryforward

    A tax loss carryforward takes place where a business or individual ...
  2. Loss Carryback

    An accounting technique with which a company retroactively applies ...
  3. Tax Umbrella

    The use by a company of the losses it sustained in previous years ...
  4. Capital Loss

    The loss incurred when a capital asset (investment or real estate) ...
  5. Short-Term Loss

    A capital loss realized on the sale or exchange of a capital ...
  6. Capital Loss Carryover

    The net amount of capital losses that aren't deductible for the ...
Related Articles
  1. Investing

    What's a Loss Carryforward?

    Loss carryforward is an accounting technique that applies a business’ net operating losses in one year to a future year’s profits.
  2. Investing

    Seek Out Past Losses To Uncover Future Gains

    Tax loss carry-forwards can help reduce the tax burden of owning a profitable fund.
  3. Taxes

    Capital Losses and Tax

    Capital losses are never fun to incur, but they can reduce your taxable income. Knowing the rules for capital losses can help you maximize your deductions and make better choices about when to ...
  4. Taxes

    Here's How to Deduct Your Stock Losses From Your Tax Bill

    Learn the proper procedure for deducting stock investing losses, and get some tips on how to strategically take losses to lower your income tax bill.
  5. Investing

    7 Year-End Tax Planning Strategies

    Do you have a capital loss that could be booked and used to offset future tax liabilities? If so, it may be time to sell.
  6. Managing Wealth

    Capital Losses and Tax

    When an investment sells for less than its purchase price, the difference is a capital loss.
  7. Financial Advisor

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  8. Taxes

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  9. Retirement

    Should You Convert Your IRA?

    Discover the factors you must weigh to make this decision.
  10. Financial Advisor

    Using Tax-Loss Harvesting to Keep Your Gains

    Harvesting tax losses is a key skill that investors can use to keep more of their money in their pockets the next time they file taxes.
RELATED FAQS
  1. What are some examples of ways businesses can use a deferred tax asset?

    Discover some of the ways U.S. businesses can use deferred tax assets on current financial statements to highlight future ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center