Tax loss carryforward is used in accounting as a way to use financial losses within a business year as a later tax liability. This deduction from tax can be used up to seven years after the year when the loss occurred. This means that should the company experience a good year in the future they can use this tax liability to reduce the amount they have to pay.
How Tax Loss Carryforward Works
In some cases this carry forward will occur naturally as it is only possible to deduct a certain amount of losses within one tax year. The accountant will then use the amount left over to deduct at a later date. It is also legal to keep the losses to be used in a year when profits are a lot higher. There is a bit of a risk in not deducting losses though, because a year of high profitability might not come and so the carryforward could be just wasted.
It is easier to understand how this carryforward works by considering an example. A company might have a very bad year where overall they have lost $10 million. If they are confident of making good profits in the future then they could decide to carry this tax loss forward. If the next year they make a profit of $10 million they will be able to use the loss of the previous year to reduce their tax liability. In this case then they would not be required to pay any tax. In the real world things are not quite as simple as this example but it is a good example of how it all works.
Tax loss carryforward isn’t just something used by clever accountants but in a lot of instances people will have no choice but to do this. This is particularly true of independent contractors who need to file a schedule C with their tax returns to the Inland Revenue. If the amount that they have lost in the year is more than the amount of profit then this will be carried over to the next tax year. Of course the contractor could decide not to claim or forget about this tax liability but most people will want to benefit from it. The availability of tax loss carryforward can make all the difference to these contractors; especially when they are initially trying to establish themselves.
Some Final Thoughts on Tax Loss Carryforward
The option to use profit losses as a means to later claim back tax is very beneficial to a lot of people. There are some critics who claim this option is a flaw in the tax system which allows people to escape taxes. There is no doubt though that the availability of this tax liability can be a great help to business who are struggling to survive. It means that even if they have had a very bad year they can benefit fully from the profits of a future year when things get better.