Question

Meatloaf Limited is a producer of food products that was established in 2015. The company is subject to U.S. federal taxes.

In its first year of operations, Meatloaf Limited made a loss of $100,000. In 2016, the company made a profit of $200,000. In 2017, Meatloaf Limited made a large loss of $300,000.

At the end of 2017, the company also had deferred tax liabilities of $40,000 on its books. Looking forward, the company expects to earn substantial pre-tax profits in future years.

During 2018, the enacted corporate tax rate changed from 40% to 35%. There were no other changes to the company’s deferred taxes during 2018.

Using the Codification, how will the company account for these transactions?

Answer 1

The Internal Revenue Service (IRS) allows businesses to carry net operating losses (NOL) forward 20 years. After that point, the losses expire and can no longer be used to reduce taxable income.

Loss carryback works the same way as loss carryforward. Essentially, a business or taxpayer applies losses from one year against gains or profits from another year. However, loss carrybacks are applied to past years' earnings, while carryforwards apply to future years' earnings.

The IRS also allows businesses and individuals to carry losses back against previous years' earnings to retroactively reduce their tax liabilities for those years, but the agency has different carryback rules for different types of losses. For example, most losses, including personal capital losses, can be carried back for only two years, but farm losses can be carried back for five years. Similarly, specified liability losses can be carried back for 10 years.

In the first year company has the loss of $100,000. The same can be carried forward for 20 years and carryback for 2 years.

So, loss of first year will be written off against the profit of $200,000 in the year 2016. So, in the year 2016, taxable income will be $100,000. In the year 2017, company has another loss of $300,000. We advice the company to carryback loss $100,000 in the year 2016 instead of carrying forward the whole loss in 2018. This is because the tax rate of 2018 is less than of the previous years.

So, for 2018, loss of $200,000 is available. This should be written off against the 2018 profits.

Deferred tax liabiility of the year 2017 of $40,000 will be carried forward in the year 2018.