Loss Carryback Definition
Loss carryback refers to a situation where a company faces a net operating loss and decides to apply it to the tax returns of the previous year. This leads to a reduced tax bill for the year this loss is carried back to since it lowers the tax liabilities experienced in that year. The net operating loss (NOL) refers to the loss portion in the current year that can be applied to previous tax years or future years. A taxpayer who owns a business incurs this loss.
A Little More on Net Operating Loss (NOL) Carryback
When calculating this loss some items are excluded, and they are:
- Net capital loss
- Deductions made for personal exemptions
- Nonbusiness deductions made more than nonbusiness income
Also, some adjustments are excluded like the following:
- The gain resulting from sale or exchange of stock from a qualified small business
- The deduction of domestic production activities
- The deduction of NOL from other tax years
Example of Loss Carryback
Assume a company has NOL of $100,000. The company can carry this loss backwards to counterbalance it with the net operating income in the prior year of $100,000. This means that the company would not have a tax liability since these two amounts would cancel out. The company can, therefore, be refunded the tax it paid on the original income of $100,000 if it has already revoked it.
The carryback period allowed for a company or an individual is three years. This enables businesses that experience loss in a certain year to use the loss carryback tool and counterbalance it with the past profitable financial results. The carryback period for small businesses was significantly increased by section 1211 of the American Recovery and Reinvestment Act (2009) to five years for NOLs that were incurred in 2008.
References for Loss Carryback
Academic Research on Loss Carryback or Carryforward
Tax loss carryforwards and corporate tax incentives, Auerbach, A. J., & Poterba, J. M. (1987). In The effects of taxation on capital accumulation (pp. 305-342). University of Chicago Press. This study utilizes data derived from corporate annual reports to investigate how much the loss-offset constraints impact corporate tax incentives.
Loss carryback and carryover provision: effectiveness and economic implications, Barlev, B., & Levy, H. (1975). National Tax Journal, 173-184. This paper demonstrates that the possibility of a US corporation recovering an accidental loss is extremely high and that the expected present value of the tax saving is also high in all corporations even the risky ones.
Tax incentives to hedge, Graham, J. R., & Smith, C. W. (1999). The Journal of Finance, 54(6), 2241-2262. This article utilizes simulations to examine the convexity aroused by tax-code provisions keeping in mind that since hedging reduces the expected tax liabilities, there is a high incentive to hedge.
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 the extent to which the length of the period of net operating loss carryback impacts corporate liquidity and marginal tax rates.
How big are the tax benefits of debt?, Graham, J. R. (2000). The Journal of Finance, 55(5), 1901-1941. This article estimates that the capitalized tax benefit of debt is equivalent to 9.7 of a firm’s value and achieves this through integrating under firm-specific benefit functions.
Employee stock options, corporate taxes, and debt policy, Graham, J. R., Lang, M. H., & Shackelford, D. A. (2004). The Journal of Finance, 59(4), 1585-1618. This paper concludes that employee stock option deductions result in massive aggregate tax savings for Nasdaq 100 and S&P 100 firms and impact the corporate marginal tax rates.
Debt and the marginal tax rate, Graham, J. R. (1996). Journal of financial Economics, 41(1), 41-73. This study carries out an investigation of whether the continued use of debt is directly related to simulated firm-specific marginal tax rates that account for investment tax credits, the alternative minimum tax and net operating losses.
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 paper investigates the various challenges experienced when using the post-acquisition NOL carryback
An empirical estimate of corporate tax refundability and effective tax rates, Mintz, J. M. (1988). The Quarterly Journal of Economics, 103(1), 225-231. This article tries to measure the effects of imperfect loss offsetting on the tax rate measurements that are industry effective.
Investment incentives and corporate tax asymmetries, Edgerton, J. (2010). Journal of Public Economics, 94(11-12), 936-952. This paper models investment decisions of firms in a setting involving, financial challenges, carrybacks and carryforwards of NOLs and also estimates the responses of investments to tax incentives allowing the effects to change with taxable status and cash flows.
Corporate marginal tax rate, tax loss carryforwards and investment functions: empirical analysis using a large German panel data set, Ramb, F. (2007). This study examines the relationship between the investment behavior of resident firms in Germany and the factually calculated marginal tax rates that John R. Graham developed.
Carryover of Business Losses, Beck, M. (1953). National Tax Journal, 6(1), 69-85. This paper investigates how businesses can carry forward their losses 20 years into the future to offset them with future profits and reduce tax liability.