Question

According to income tax, the deduction of Net Operating Losses and carry back, carry forward

Carmichael Corp. has been successful with taxable income of $50,000 in each of the last three years. The corporate tax rate in each of these years was 35%. In the current year, business took a turn for the worse and Carmichael reports a $180,000 loss. What tax benefit, if any, will Carmichael receive from this loss assuming Carmichael returns to profitability the following year and earns $50,000 in each future year? What if Carmichael never returns to profitability again?

Answer 1

When a business reports operating expenses on its tax return that exceed its revenues, a net operating loss (NOL) has been created. An NOL can be used in some other tax reporting period as an offset to taxable income, which reduces the tax liability of the reporting entity. The basic rules for using an NOL are:

1. Carry the amount back to the preceding two tax years and apply it against any taxable income, which can generate an immediate tax rebate. You can waive this action and instead proceed directly to the next step; if so, attached a statement to your tax return in the year in which the NOL was generated, documenting the waiver.
2. Carry the amount forward for the next 20 years and apply it against any taxable income, which reduces the amount of taxable income in those years.
3. After 20 years, any remaining NOL is cancelled.

It makes financial sense to apply the NOL against the earliest periods possible, since the time value of money concept dictates that the tax savings in these periods is more valuable than for any tax savings in later periods.

If NOLs are being generated in multiple years, use them in the order the NOLs were generated. This means that the earliest NOL should be completely drawn down before the next oldest NOL is accessed. This approach reduces the risk that an NOL will be terminated by the 20-year rule noted earlier.

In this case, if Carmichael return profitability in the following years it can carry forward its loss of the current year to next year in the following year:-

Current Year	(180,000)
next year 1	50,000	(130,000)
next year 2	50,000	(80,000)
Next year 3	50,000	(30,000)
Next year 4	50,000	20,000

In the next forth year than Carmichael has to pay tax on $20,000.

If Carmichael never returns to profitability, there is no point of carry forward of losses.