What is a loss carryforward?
Loss carryforward is an accounting term that describes a situation in which a business experiences a net operating loss and chooses to apply that loss to a previous year’s tax return. This results in a lower tax bill for the year to which this “carried forward” loss was applied, as it reduces the taxes payable for the previous year. The loss carryforward may generate a tax refund for the business for the previous year due to this newly reduced tax obligation. Once the loss carried forward has been applied, it will be as if the company has paid its overpayments for that year. Generally, losses can only be carried forward two years before the year in which the net operating loss occurred. Special circumstances allow losses to be carried back over three years
Explanation of loss carry-over
Loss carryforwards are similar to loss carryforwards, except that companies apply their net operating losses to revenues in previous years rather than in subsequent years. Unless certain circumstances are present, loss carryforward can only be applied to the two years preceding the year in which the net operating loss occurred.
Example of loss carryforward
For example, if a business were to record a net operating loss in its fifth year of operation, it could apply a loss carryback to the third year of its operation. If the loss carryforward completely offsets the entire tax liability incurred by the business in the third year, the remaining loss could be applied to the fourth year. If there was an amount of loss after elimination of the tax obligation in the fourth year, the amount of the additional loss could then be applied to operating years six, seven and so on until the amount of the loss be fully utilized. While loss carryforwards can generally only go back two years, loss carryforwards can extend up to 20 years after the year in which the net operating loss occurred.
A business can choose how to apply a net operating loss when such a loss occurs. He can choose to postpone the loss or to postpone it. A business may choose to carry over the loss if it expects an increase in tax liability in the future. However, once a choice has been made to carry the loss forward or backward, the action cannot be canceled.