If upon filing your 2014 income tax return you found that your business activity had a net operating loss (NOL) — that is, deductible expenses exceeded revenue — there is a silver lining: a tax break. Your business can use the NOL to reduce a prior year’s or a future year’s taxable income, thereby generating current and/or future tax savings. But which is better, carrying the NOL back or carrying it forward?

Playing by the Rules

Generally an NOL must first be carried back two years unless an election is made not to. This can produce an immediate refund of taxes paid in the carryback years. From there, any remaining losses are carried forward to offset income year by year until either they’re used up or you hit the maximum 20-year carryforward period.

You have the option, however, to elect to forgo the carryback years and instead only carry the NOL forward. While this won’t create an immediate tax refund, it could ultimately save more taxes, depending on the situation. One word of caution: Once the election to forgo the carryback years is made, it is irrevocable.

Balancing Act

Determining which option is better involves comparing your tax brackets in the carryback years with your expected tax brackets in the carryforward years. Because reductions save more money when you’re subject to higher tax rates, if you expect to be in a higher tax bracket in future years — or if you expect tax rates to go up — you may be better off forgoing the carryback and carrying the entire NOL forward.

Another consideration is that a number of states don’t allow carrybacks of NOLs. This further limits the benefit and must be part of the carryback/carryforward comparison.

Even if you project that a carryforward will save you both federal and state taxes, you’ll want to balance this with the benefit of an immediate influx of cash that a carryback claim can provide. Finally, keep in mind that your expectations for future years are speculative, whereas the tax you already paid in the carryback years is known.

Your Best Option

When deciding whether to carry back or carry forward an NOL, all things must be considered. And if your business is a flow-through entity rather than a traditional C corporation, the rules surrounding NOLs are a little more complicated. Owners of a pass-through entity can enjoy NOL tax benefits by offsetting other income at the individual level. This isn’t possible for C corporation shareholders.

Not sure how the NOL rules apply to your business or what your best option is for taking advantage of an NOL? Contact us. We can review your situation and help you determine the strategy that will most effectively help you achieve your goals.