A tax carryforward is a provision in tax law that allows a taxpayer to apply some unused deductions, credits, or losses to a future tax year. The IRS and some states allow carryforwards, sometimes referred to as tax loss carryforwards, net operating loss (NOL) carryforwards, deduction carryforwards, or credit carryforwards.
Tax carryforwards typically occur when the IRS or a state's Treasury department has placed a limit on the amount that can be deducted or claimed for certain items in any single year. You might have more of a deduction than you're permitted to claim in the current year, but you can carry the balance over to next year's return.
Not all tax deductions and credits qualify for tax carryforwards, so keep reading for more information.
Definition and Example of a Tax Carryforward
A tax carryforward is when a taxpayer can apply some unused tax deductions, credits, or losses to a future tax year. It is meant to help people and businesses reduce their tax liability.
- Alternate name: Tax loss carryforwards, net operating loss carryforwards, deduction carryforwards, credit carryforwards
The New York Times reported in 2016 that President Donald Trump claimed $916 million in losses in 1995, and federal tax carryforward laws likely allowed him to spread out those losses over 18 years, eliminating or reducing his tax liability along the way.
This is just one example—and may be extreme and uncommon—but the ability to spread out losses does exist to help businesses and even individuals endure difficult times and recover more quickly.
How a Carryforward Works
As an example, a state might limit deductions on Section 529 plan contributions to $5,000 for a given year, so a taxpayer's $8,000 contribution would be only partially deductible. The additional $3,000 could be deductible in a later year, however, if the state offered a tax carryforward provision on Section 529 deductions.
A number of the states that offer Section 529 contribution deductions also offer carryforward provisions on excess amounts. Speak to a financial advisor or contact the appropriate government agency in your state about carryforward provisions there.
Taxpayers can increase the total amount of what is deductible over a longer period of time by carrying forward contribution amounts in excess of their state's limit.
Types of Carryforward Losses
The most common federal carryforward provisions are investment losses classified as "ordinary losses," as opposed to long-term losses.
A carryforward is also available for charitable donations that exceed 50% of a taxpayer's income.
Some tax carryforwards have no time limit and can be used as long as the taxpayer is alive. Other tax carryforwards expire after just a few years, depending on each carryforward rule.
The federal adoption tax credit is nonrefundable. It can eliminate any tax you owe the IRS, but you won't receive a refund for anything that's leftover. You won't lose any of the balance, however, because any unclaimed/unused portion of the credit can be carried forward for up to five years.
Capital losses can be carried forward on your federal return as well. You can deduct up to $3,000 a year in capital losses that exceed your capital gains, and carry forward any balance to a future tax year.
Requirements for Carryforward Losses
The IRS limits what may be deducted to determine if a taxpayer has a net operating loss, which occurs when deductions exceed income. Any of the following are excluded when determining losses, according to the IRS:
- Any deduction for personal exemptions prior to 2018
- Exclusion of gains from the sale or exchange of qualified small business stock, typically allowed under IRS Section 1202
- Nonbusiness deductions in excess of nonbusiness income
- The net operating loss deduction
- The domestic production activities deduction
- A portion of some tax deductions and tax credits can go unused because these tax breaks have dollar limits as to how much a taxpayer can claim.
- A tax carryforward lets taxpayers claim the unused portion of these deductions, losses, and credits in future tax years if they cannot do so in the current tax year.
- Not all credits and deductions have carryforward provisions.
- The most common tax perks that enjoy carryovers include the adoption tax credit, the charitable contribution itemized deduction, 529 plan deductions at the state level, and capital losses.