What is carry back?
Carry back is a special provision that allows transfer of a net loss of a particular year to the preceding years, mainly to ease the tax burden.
“Carry back” is an accounting technique where a company applies parts of the current year’s net operating losses to the income of the preceding year. In other words, a year’s tax loss may be used to offset profits in previous years. This technique is a legal method of reducing the tax liability of the current year.
A net operating loss arises when tax deductions and operating expenses exceed the income realized in a particular financial period. These losses can be carried back to ease the year’s tax burden. This loss can be apportioned anywhere during the three preceding years.
A loss carry back has similar dynamics to those of a carry forward. The difference is that the carry forward apportions the operating losses to future periods. In this method, losses can be carried forward and applied within seven years after the operating loss has been incurred.
The IRS recommends that records for any year involving a net operating loss should be kept for three years after the expiration of the carry forward.
The process of claiming a carry back begins by completing the tax return that is relevant to the type of business. If the net loss realized is greater than the income earned, one can proceed with the carry back process to the previous year.
Carry back example
Let’s say a company earned income of $6 million in 2015. In the next year (2016), the company had a loss of $3 million. By apportioning the loss to the previous year, the profits of 2015 are reduced to $3 million. This method of apportioning the loss to the previous year’s income is the carry back process.
To understand the concept of tax deductibles, it would be prudent to review this list of tax deductions.