Tax Loss Carryforward

Written By:
Paul Tracy
Updated August 12, 2020

What is a Tax Loss Carryforward?

A tax loss carryforward is a "negative profit" for tax purposes. It usually occurs when a company's expenses exceed revenues, making the company unprofitable.

How Does a Tax Loss Carryforward Work?

Tax loss carryfowards reduce future tax payments. For example, let's assume Company XYZ has income of $1,000,000 but expenses of $1,300,000. Its net operating loss is $1,000,000 - $1,300,000 = -$300,000.

Company XYZ will probably not have to pay taxes that year, because it has negative taxable income. But let's assume that next year, Company XYZ makes a lot more money and records $500,000 of taxable income. Company XYZ pays a corporate tax rate of 30%.

Normally, the company would need to pay $500,000 x 30% = $150,000 in taxes. But because it had a tax loss carryforward from last year, it can apply last year's loss to this year's tax bill, reducing it significantly (or even to $0, depending on the jurisdiction Company XYZ is in).

Let's assume that Company XYZ can apply the entire -$300,000 tax loss carryforward to this year's tax bill. Instead of owing $500,000 x 30% = $150,000 in taxes, Company XYZ now owes only ($500,000 - $300,000) x 30% = $60,000 in taxes.

Similarly, investors can carry forward losses from selling investments and thereby reduce their taxes on future capital gains.

Why Does a Tax Loss Carryforward Matter?

Tax loss carryforwards create future tax relief for companies and are therefore very valuable. The laws on how tax loss carryforwards apply vary by state, but usually a carryforward from the last two or three years can apply up to the next seven years. After that, the carryforwards expire. There are rules and exceptions for almost any circumstance, so it's best to check with the IRS or a qualified tax accountant when calculating and applying tax loss carryforwards.

As mentioned above, tax loss carryforwards are valuable assets in and of themselves. In fact, sometimes companies purchase other companies solely for their tax loss carryforwards.