Tax Loss & Carry-Forward Rules


In the early stages of a business, it is common to incur losses. In the first couple of years, a business can lose money as it gradually implements a business plan and puts together a strategy to eventually become profitable. The Internal Revenue Service has guidelines in place that allow small businesses of any type -- sole proprietorship, partnership or corporation -- to carry forward the tax loss from one year to future years that it is anticipated will be more profitable. You may take a deduction in future years based on the losses you incur today.

Net Operating Loss

The decision to carry a loss forward stems from the determination of your net operating income. If your gross revenues are less than your total expenses and business costs, you will have a negative net operating income. In short, your business has lost money. When it comes time to file your tax returns, you will be able use the amount of the business loss as a deduction on your federal return. For individual taxpayers and sole proprietorships in 2011, this amount was entered on line 41 of Form 1040. For corporations, this amount was entered on line 28 of Form 1120.

Definition of "Carry Forward"

When you decide to take a tax loss under "carry forward," you decide to take an operating loss charged against income in future years. In this practice, you mitigate the impact on financial statements at present in exchange for spreading out the net operating loss over future years. The loss taken in the current period is thus carried forward into future filing periods.

Carryback Option

Before carrying forward any losses, you may wish to use the net operating loss as a carryback. A carryback allows you to carry the losses back two years to offset income of the previous two periods. Carrying back losses is generally the default requirement, but you can waive this option by attaching a statement to your current tax return signifying that you are choosing only to carry forward the loss. In such a case, indicate that you are waiving the carryback period under IRS Section 172(b)(3).

Advantages of Carry Forward

A net operating loss can help you offset positive income in future years. If your net income will increase in future years, it would be advantageous to defer the deduction for operating loss into the profitable years expected in the future. This will reduce your future tax liability.

You can choose to carry the loss forward for up to five years, based on the American Recovery and Reinvestment Act (ARRA) passed in 2010. Prior to the bill's passage, businesses had only two years to carry the loss forward.

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