Definition
Loss Carryover is a tax provision that allows taxpayers to apply a net operating loss (NOL) to future taxable periods. This mechanism helps offset taxable income in subsequent years with losses from previous years, ultimately reducing the tax liability. Loss carryovers come in two main forms: carryforwards and carrybacks. Carryforwards permit a taxpayer to use the NOL in future tax years, while carrybacks allow the NOL to be applied to previous years, thereby generating a tax refund.
Examples
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Corporate Taxpayers: A corporation that experiences a net operating loss in the current fiscal year can apply this loss to its taxable income in future years. If the corporation earns significant profits in succeeding years, the NOL from the losing year can reduce the amount of taxable income, resulting in lower tax liabilities.
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Small Business Owners: A small business reporting losses can use the NOL provision to either carry the losses back to previous profitable years and reclaim taxes paid, or carry forward these losses, applying them to future profitable years to reduce the taxable income.
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Individual Taxpayers: For individuals who have investments or businesses that report operating losses, the loss can be used to offset other income in future years, effectively lowering the total personal taxable income for those years.
Frequently Asked Questions (FAQs)
1. What is the difference between a loss carryover and a carryback?
Answer: A loss carryover allows a taxpayer to apply a net operating loss (NOL) to future tax years to offset taxable income, reducing future years’ tax liabilities. A carryback, on the other hand, permits the taxpayer to apply the loss to previous tax years, potentially resulting in a tax refund for those years.
2. How many years can NOLs be carried forward?
Answer: Under the Tax Cuts and Jobs Act (TCJA) of 2017 in the United States, NOLs arising in tax years beginning after December 31, 2017, can be carried forward indefinitely, but the deduction is limited to 80% of taxable income. Prior to this, NOLs could generally be carried forward for up to 20 years.
3. Can individual taxpayers use loss carryover for personal losses?
Answer: Yes, individual taxpayers can use loss carryover for business-related and investment-related losses. However, personal losses such as those from the sale of personal property are generally not eligible for NOL treatment.
4. Do all countries allow loss carryover?
Answer: No, tax laws vary significantly from country to country. Most developed nations provide some form of loss carryover mechanism to prevent double taxation, but the rules and periods for carryovers vary widely.
5. Are there any limitations on how much loss can be carried over?
Answer: Yes, there are typically limitations on the amount of NOL that can be used each year. For instance, under the TCJA, NOLs used to offset taxable income in a future year are limited to 80% of taxable income for losses arising after December 31, 2017.
Related Terms
Net Operating Loss (NOL)
A Net Operating Loss occurs when a company’s allowable tax deductions exceed its taxable income within a tax period.
Tax Carryforward
A tax carryforward is the ability to apply unused tax credits or NOLs to future tax periods.
Tax Carryback
A tax carryback policy allows taxpayers to apply the NOL to previous tax periods, potentially generating a refund.
Deferred Tax Asset
A deferred tax asset is created when a company pays more tax in a given period than is actually due, leading to credits that can be used in future taxable periods.
Income Tax
A tax levied by government directly on income, especially an annual tax on personal income.
Online Resources
Suggested Books for Further Studies
- “Federal Income Tax: Code and Regulations–Selected Sections” by Martin B. Dickinson
- “Understanding Corporate Taxation” by Leandra Lederman
- “Practical Guide to Mergers, Acquisitions and Business Sales” by Joseph B. Darby
Fundamentals of Loss Carryover: Taxation Basics Quiz
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