Loss Carryback Definition
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.
A Little More on What is Loss Carryback
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 firm’s 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.
References for Carryback
Academic Research for Carryback
The effects of the length of the tax-loss carryback period on tax receipts and corporate marginal tax rates, Graham, J. R., & Kim, H. (2009). (No. w15177). National Bureau of Economic Research. This paper investigates how long the carryback period of net operating loss influences marginal tax rates and corporate liquidity. The authors evaluate that making an extension to the carryback period from 2-5 years, as presently offered in the budget blueprint of President Obama will provide 19 billion USD of extra liquidity to the corporate sector for the year 2008. The government will concentrate on the advantages of the extended carryback period in the automobile, home building and financial sectors. It will move the marginal tax rate of the loss firms by above two hundred base point. The findings are that the tax break offered by the Obama government will leave an important liquidity impact on corporations that faced huge losses this year.
Loss carryback and carryover provision: effectiveness and economic implications, Barlev, B., & Levy, H. (1975). National Tax Journal, 173-184. The economic value underlying the carryover provision and loss carryback varies country-country according to their offsetting regulations. The authors show that the expected current value of the tax savings increases even for risky corporations. They also demonstrate that the provision creates discrimination in new firms and it influences their decision to accept risk projects as a challenge. The authors discuss the possible impacts on the financing policy of the firm. This research concludes with a global comparison of the provision effectiveness in different countries. The authors elaborate on the economic implications of this comparison in detail.
A Case for Neutrality in the Design and Implementation of the Merger and Acquisition Statutes: The Post-Acquisition Net Operating Loss Carryback Limitations, Larue, D. W. (1987). Tax L. Rev., 43, 85. This research is based on a case for neutrality in the implementation and design of the acquisition and merger statutes. The author describes the Carryback limitations and the post-acquisition net operating loss as a result of these limitations or constraints.
Short-term incentive effects of a reduction in the NOL carryback period, Albring, S. M., Dhaliwal, D. S., Khurana, I. K., & Pereira, R. (2011). Journal of the American Taxation Association, 33(2), 67-88. This paper examines whether the TRA 1997 (Taxpayer Relief Act) that minimized the NOL (Net Operating Loss) carryback period from 3-2 years, left a short-term incentive impact to transfer income in 1997, the tax year to rapidly increase loss recognition. The findings are that the NOL firms sample in 1997, the treatment year shows higher or lower levels of income, decreasing or increasing earnings management than a loss firms control sample. When, in the transition year, the authors emphasize on the NOL companies strictly, companies with the higher reported expense of income-tax in 1995, the fiscal year, show greater income transfers to rapidly increase loss recognition. Finally, the tax law provision changes influence the reporting behaviour of firms.
Estimating the tax advantage of corporate debt, Cordes, J. J., & Sheffrin, S. M. (1983). The Journal of Finance, 38(1), 95-105. This article estimates the value of effective tax of incremental interest deductions for large companies considering that they may not utilize all of the interest deductions completely due to inadequate taxable income or the access of non-debt tax shields. After stating certain characteristics of the tax code that may drive a wedge in effective and statutory tax rates for debt financing, the authors provide estimates with the help of TCTM of effective tax rates (Treasury Corporate Tax Model) for a number of industry groups. The estimates made by the authors suggest widely varying the debt after-tax cost across industries.
Tax-induced earnings management by firms with net operating losses, Maydew, E. L. (1997). Journal of Accounting Research, 35(1), 83-96.
The significance of tax law asymmetries: An empirical investigation, Altshuler, R., & Auerbach, A. J. (1990). The Quarterly Journal of Economics, 105(1), 61-86. This paper takes tax return data for the United States non-financial corporates for the period of 1971 to 1982 to analyze the significance of restrictions on the firm’s ability to get refunds for tax losses and use tax credits. The findings are that the incidence of these unused tax advantages raised sustainability in the early 1980s, though these increments are not attributable to high investment incentives, meanwhile. The authors show marginal tax rates estimates on interest payments that consider unused tax advantages and focus on the significance of differentiating present tax payments from marginal tax rates in assessing the investment incentive.
Evaluating deferred tax assets, Petree, T. R., Gregory, G. J., & Vitray, R. J. (1995). Journal of Accountancy, 179(3), 71. The recognition of deferred tax assets is highly complex area of the FASB statement number 109 (Financial Accounting Standards Board), Accounting for Income Taxes. Firms should decrease deferred tax assets using a valuation allowance, if it will not realize all or some of them. Circumstances of every firm and the management’s’ evaluation affect implementation of this provision. This paper guides in fixing valuation allowances, explains recognition criterion application in different circumstances and briefly highlights deferred tax asset related data which the firms financial statements disclose. The authors suppose the Federal Tax Rate of the United States as 34 percent.
Measuring corporate tax rates and tax incentives: a new approach, Graham, J. R., & Lemmon, M. L. (1998). Journal of Applied Corporate Finance, 11(1), 54-65. This paper assesses that the expected tax advantages from interest deductions by all United States corporations (publicly traded) were accountable for nearly 1.4 trillion USD of total market value (12.7 trillion USD) in 1991. The authors argue that the process of corporate planning to increase wealth of shareholders should comprise a careful evaluation of corporate tax incentives m. The authors demonstrate how the tax code provisions and earnings variability interact to influence expected marginal tax rates of a company. When a company measures marginal tax rates before financing, it shows a positive relationship between tax rates and debt usage.
Carry–Back of Unused Excess Profits Credit and Net Loss, Orfield, L. B. (1944). Minn. L. Rev., 29, 229.
FASB 109: Auditing considerations of deferred tax assets, Peavey, D. E., & Nurnberg, H. (1993). Journal of Accountancy, 175(5), 77. This paper explains the auditing rules of deferred tax assets as states in the FASB 109. The FASB (Financial Accounting Standards Board), in Feb 1992, issued statement number 109, Accounting for Income Taxes (AIT) that demands a revision of the asset-liability model interperiod Income tax allocation. Both of its versions are balance sheet oriented and identify the tax impacts of temporary differences. The major difference is the deferred method that is income statement oriented while the credits are identified for the tax impacts of timing differences. The statement number 96 does not allow identifying deferred tax assets until they are identifiable by offset or carryback.