Tax Loss Carryforward Definition
A tax loss carryforward (also known as Net Operating Loss Carryforward)is a type of provision which shall allow either a business or an individual taxpayer to carryforward a loss that is tax loss to future years to offset the future gain or profit. The tax loss that is carried forward which shall be claimed by a business or an individual in order to reduce any tax payments in the future.
Type of Tax Loss Carryforward
There are two sub-major categories who can claim tax loss carryforward.
#1 – Business
They can utilize these losses carryforward provisions against NOL which stands for net operating loss, capital losses which are more than the capital gains, and certain gains which are earned from the exchange or sale of stock of the small qualified business.
#2 – Individual Taxpayers
They may use these tax loss carryforward provisions for many various circumstances, and that information can be extracted from the IRS and from their respective taxing authority of the state. Take an example, if a taxpayer makes excess contributions to a 529 plan of the state, the taxpayer can’t deduct the amount which he has deposited in excess, but the taxpayer shall be able to carry that amount to the future years.
Examples of Tax Loss Carryforward
Below are the examples of Tax loss carryforward.
Tax Loss Carryforward – Example #1
Questa power company a profit-making company in the town has been recently affected by the prices of coal due to its huge demand and less supply. Below is the snapshot of recent monthly below income statement and their tax payment.
Using the below information, we will calculate the amount of tax loss that the company can carryforward and what is remaining in balance that has to be utilized.
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Solution:
Till the month of Feb, the company was making profits and was paying tax at the rate of 30%, but after March month the company didn’t pay any tax till June as they were incurring losses per below.
We can see that from March onwards the loss was initiated and the same is getting carried forward until the company starts making a profit which happens only in the month of June.
Till May month the company accumulated a loss of $21,000 and same was offset partially by the gain of $5,000 and now the remaining loss to be absorbed in the future is $16,000.
Tax Loss Carryforward – Example #2
One of the famous examples could be of President Donald Trump of the US and who is also a businessman. In year of 2016 while electing for the president of US, the New York Times, a renowned publisher, released tax return of Donald Trump for the year 1995 in which loss of $916 mn was reported that happened in the year 1995, which was carryforward to offset in the future years against the future income.
The losses that were realized capital losses that arrived from the investments that Trump made in airline business ventures, casinos, and the Manhattan property. The same publisher reported that this loss of $916 million would allow Mr trump to escape federal tax of approximately $50mn up-to eighteen taxable years.
Pros
- Tax loss carryforwards are beneficial as they create future tax relief for the business or the companies and hence they are very valuable for them.
- These losses can be generally carried for seven years per the laws which again provides relief to companies as and when they make the profit they won’t be required to pay tax immediately which ultimately removes pressure from them for cash outflow and working capital would be managed properly.
- In some of the cases, the companies acquire another company solely for tax loss carryforward purpose.
Cons
There is no major disadvantage per se for tax loss carryforward, only thing is it can make the business or the company look like loss-making company.
Important Points to Note
Following points must be noted before carrying forward the tax loss.
- One should complete the tax return that is applicable to the type of business.
- Determine whether your tax deductions exceed the taxable income and there is net operating loss which should not be complicated to compute for the taxpayer.
- Also, certain laws require that tax return should be filed within the due date in order to claim and carried forward losses for the future, do make note of same.
- There could various heads of income and there are laws which treat them differently and so as their tax losses carryforward rule, the taxpayer should make note of same.
Conclusion
There is one crucial point to note that each and every country has their own set of rules and regulations that shall govern the set-off and carryforward of the net operating losses for the taxpayers whether being individual or business. These rules and regulations are not simple and perhaps they are complex, and they would require careful considerations of each and every provision, perhaps the help of local tax attorney. For e.g. in the United States of America (USA), each and every state has its own set of rules and regulation which are governing the tax code. 30 states and DC which conform to the federal tax code of allowing twenty years of Net Operating Loss to be carryforward. While Illinois which allows twelve years of carrying forward and whereas Kansas and Vermont they allow for ten years of loss carryforward.
Last but not least, the taxpayer should keep excellent tax records of the claims that he makes in the tax returns.
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This has been a guide to Tax Loss Carryforward. Here we discuss its definition and the two sub-major categories who can claim tax loss carryforward. Here we also discuss its advantages and disadvantages along with some examples. You can learn more about financing from the following articles –
