What is the Loss Carryback Rule? 

Loss carryback is a term used in the accounting industry at the time when a firm incurs a net operating loss, and opts for applying that loss on the tax return of a previous year. As a result, the tax liability for the year when this loss was carried back reduces. It further enables the business to have a tax refund for the prior year owing to the exclusive decrease in tax liability. Once the loss is carried back to the previous year, it will seem as if the firm made overpayment of taxes in that specific year. Generally, a firm can make a loss carryback for the last 2 years when it experienced a net operating loss. However, there can be special cases where the companies may receive a loss carryback for 3 years.

How Does the Loss Carryback Rule Work?

The concept of loss carryback is same like loss carryforwards. The only difference is while the companies implement their net operating loss to coming years in loss carryforward, they use their net operating loss to previous years in the case of loss carryback. Except for some specific situations, a company can apply its loss carryback to the 2 years prior to the year when the net operating loss took place.

Example of Loss Carryback

For example, if a firm had a net operating loss in its 5th year of operations, its loss carryback would be applied to either third or fourth year of its business. If the loss carryback results in the total offsetting of the firms tax liability in the third year, then it can allocate the remaining amount of loss to the fourth year. In case, there is still some loss remaining after being allocated to year 4, the excessive amount of net operating loss would be applied to year 6, 7, and so on until the whole amount of the loss is totally utilized, or becomes zero. Though loss carryback usually covers the last two years, the loss carryforward can be applied up to a time period of 20 years post such losses took place. Every business has a different strategy to apply when it comes to applying a net operating loss. Some may prefer to apply the loss to the preceding years, while some may prefer to apply it to the coming years. In case, a business predicts that its tax liability is likely to increase in the coming years, it will apply the concept of loss carryforward. But, any decision, of whether to carryback or carryforward the loss, is irreversible. Hence, the company needs to be very confident of the approach that it selects.