Loss Carryforward

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Loss Carryforward: Definition, Example, and Tax Rules

What is a loss carryforward?

A loss carryforward (often a net operating loss, NOL, carryforward) lets a business apply a current-year loss against taxable income in future years. By offsetting future profits with earlier losses, a company reduces its future tax liability. The term also applies to capital loss carryforwards.

Key points

  • Loss carryforwards reduce future taxable income by applying current-year losses to later years.
  • For NOLs arising in tax years beginning on or after Jan. 1, 2018, the Tax Cuts and Jobs Act (TCJA) eliminated the general two-year carryback, allows indefinite carryforwards, and limits annual use to 80% of taxable income.
  • NOLs originating before Jan. 1, 2018 remain subject to the former rules (including the 20-year carryforward limit and available carrybacks).

How the rules work

  • Pre-2018 NOLs: Subject to older carryover rules — generally up to a 20-year carryforward and possible two-year carryback (depending on the period and rules in effect).
  • Post-2017 NOLs: TCJA removed the general two-year carryback and permitted indefinite carryforwards. Use of these carryforwards in any future year is limited to 80% of that year’s taxable income.
  • NOL carryforwards are recorded as deferred tax assets on the balance sheet and are drawn down each year as they are used, subject to the 80% annual limit.

How businesses should use carryforwards

  • Claim losses as soon as practical. Carryforwards are not inflation-adjusted, so their real value falls over time.
  • Record NOL carryforwards as deferred tax assets to reflect the future tax benefit.
  • Plan around the 80%-of-income limit when forecasting tax impact and cash flow.

Examples

  1. $5 million loss followed by $6 million income:
  2. 80% of $6 million = $4.8 million can be applied in year two.
  3. Taxable income after applying the carryforward = $6M − $4.8M = $1.2M.

  4. Remaining deferred tax asset = $5M − $4.8M = $200,000.

  5. $10 million loss followed by $12 million income:

  6. 80% of $12 million = $9.6 million applied.
  7. Taxable income after applying carryforward = $12M − $9.6M = $2.4M.

Carryforward vs. carryback

  • Carryforward: Apply a current loss to future taxable income to reduce future taxes.
  • Carryback: Apply a current loss to a prior year’s tax return, which can produce an immediate refund of taxes previously paid (availability depends on the tax-year rules that apply to the loss).

Bottom line

Loss carryforwards are a valuable tax feature that smooths the effect of cyclical or one-time losses by offsetting future taxable income. Rules depend on when the loss arose: losses beginning in tax years after Dec. 31, 2017 are generally carried forward indefinitely but are limited to offsetting 80% of taxable income in any given year, while older losses may remain subject to prior carryback and 20-year carryforward rules. Use carryforwards promptly for maximum real-dollar benefit.