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The Effects of Carrybacks and Carryforwards in Corporate Taxable Income

written by: John Garger•edited by: Michele McDonough•updated: 9/9/2010

Corporations reporting negative income may carryback or carryforward these losses into other fiscal years. Sometimes a refund of previously-paid taxes is returned to these companies.

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    Fluctuations in market conditions, devaluing of currency, and bad decision-making all contribute to a company’s inability to show a profit during a fiscal year. One of the problems with business plans is that they do not always coincide with yearly schedules and tax periods. Most companies, large and small, have periods of loss where no income taxes are due. These periods of non-profitability can be used to a corporation’s advantage by claiming these losses not only in future tax periods, but past tax periods as well.

    A corporation that realizes a negative income, or income loss, has the option to offset previous periods of profitability and carry back the loss. This carryback can be claimed for as much as three previous periods. For example, suppose a company is profitable in years one and two but loses money in year three. Year three’s losses can be carried back and the corporation can re-file its taxes and get a refund from the government on taxes paid in the previous periods.

    When the three allowed past periods are used up, the corporation may carry forward losses to periods in the future for up to fifteen years. This carryforward can be applied to future positive income when the losses exceed the three previous year’s profits.

    This option to offset taxes gives a corporation the flexibility to remain profitable without regard for the scheduling of taxes due when projects and investments do not fit within the tax period framework. It is a fact that many new corporations experience losses for the first few years of operations. This flexibility in tax liability reduces the risk of a corporation’s owners by allowing expected losses to be applied to other tax periods.

    Current tax laws allow corporations to carryback and carryforward losses and apply them to past and future income. The risk reducing effects of this option ensure that confidence in the corporation is not lost before the organization has a chance to show profitability.