What Is a Tax Carryforward?
...and How Does it Help Me Save for College?
Tax carryforwards allow taxpayers to save unused deductions, credits, or losses and apply them 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.
How Tax Carryforwards Arise
Tax carryforwards sometimes occur when the IRS or a state's treasury department places a limit on the amount that can be deducted for certain items in any one year.
For example, a state might limit deductions on Section 529 plan contributions to $5,000 for any given year, meaning a taxpayer's $8,000 contribution would be only partially deductible. However, if the state offers a tax carryforward provision on Section 529 deductions, the additional $3,000 could be deductible in a later year.
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
- Capital losses in excess of capital gains
- 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
College Savings Benefit
Section 529 savings plans provide tax-free earnings as long as the money in the account is used for qualifying college expenses.
Such expenses include tuition, room and board, textbooks, supplies (including computers), and school-sponsored study-abroad programs. States that allow tax carryforwards, as of 2019, include:
- District of Columbia
- Rhode Island
By carrying forward contribution amounts in excess of a state's limit, taxpayers can increase the total amount of what is deductible over a longer period of time.
The Example of President Donald Trump
The 45th president of the United States, Donald Trump, serves as a good example of how tax carryforwards can benefit taxpayers. The New York Times reported in 2016 that 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.
The Trump example is extreme and uncommon. The ability to spread out losses exists to help businesses and even individuals endure difficult times and recover more quickly.
Common Federal Carryforward Provisions
The most common federal carryforward provisions are investment losses classified as "ordinary losses" (as opposed to long-term losses) and the carryforward on charitable donations that exceed 50% of a taxpayer's income. Additionally, a number of the states that offer Section 529 contribution deductions also offer a carryforward provision on excess amounts. Speak to a financial advisor or contact the appropriate government agency in your state about the carryforward provisions there, or the lack thereof.
Some tax carryforwards have no time limit and may be used as long as the taxpayer is alive. Other tax carryforwards expire after just a few years, depending on each carryforward rule.