What it means
The most common form is the net operating loss carryforward, where trading losses are stored and offset against later profits. Capital losses, unused interest deductions and certain tax credits can also be carried forward, each usually under its own separate set of rules.
Most modern tax systems allow losses to be carried forward indefinitely but cap how much profit they can shelter in any single year, commonly around 80%. The effect is that a profitable company with large stored losses still pays some tax every year rather than none.
For accounting purposes a carryforward creates a deferred tax asset, which is the expected future tax saving recorded on the balance sheet today. It only goes on the balance sheet if management can support the view that sufficient future taxable profit will exist to use it.
Where that support is weak, the asset is reduced by a valuation allowance or simply not recognised, which is a strong public signal about how confident management is in the recovery. Reversing that allowance later, when trading improves, produces a large one-off credit in the tax line that can flatter reported earnings.
The nuance that catches acquirers out is that carryforwards often do not survive a change of ownership. Many jurisdictions restrict or cancel stored losses when a company changes hands, so a target's loss balance may be worth far less than a buyer assumes.
In practice
Real-world examples.
Example
A biotechnology company accumulates $30 million of losses over eight years of research before its first product approval. It records no deferred tax asset while losses continue, then recognises a large one when the first profitable year makes future recovery credible.
Example
A retailer emerging from a difficult restructuring uses its carryforward to shelter 80% of its recovery-year profit. Cash tax stays low for three years, which the treasury team factors into the covenant headroom it presents to lenders.
Example
An acquirer performing due diligence on a target with $12 million of stored losses discovers that the change-of-control rules will severely restrict their use. It reduces its offer accordingly rather than paying for a benefit it cannot access.
Think of it
“Carryforward lets you use unused tax benefits later-saving losses or credits for future use.
Formula
Calculation
Usable loss this year = the lower of the stored carryforward and the annual limit, where the limit is commonly a percentage of current taxable income. Remaining carryforward = opening balance - amount used.
Worked example. A software business enters the year with a $500,000 net operating loss carryforward. It reports taxable income of $400,000, the annual limitation is 80% of taxable income, and the tax rate is 21%.
Maximum usable this year = 80% x $400,000 = $320,000.
Taxable income after offset = $400,000 - $320,000 = $80,000.
Tax payable = $80,000 x 21% = $16,800.
Without the carryforward the bill would have been $400,000 x 21% = $84,000, so the saving is $84,000 - $16,800 = $67,200, which is $320,000 x 21%.
Remaining carryforward = $500,000 - $320,000 = $180,000, available against future years.Case study
Seen in the real world.
This is a fictional, illustrative example. Larkspur Analytics, an invented data business, spent four loss-making years building its platform and entered its fifth year with a $500,000 net operating loss carryforward and its first profitable outlook.
The year delivered $400,000 of taxable income. With an 80% limitation the company sheltered $320,000, paid tax on $80,000 at 21% for a bill of $16,800 instead of $84,000, and carried $180,000 forward. The $67,200 saved funded two additional engineering hires.
The more interesting effect was on the accounts. Having previously written the deferred tax asset down to nil on the grounds that future profits were uncertain, the finance director reinstated part of it, which produced a credit in the tax line and made reported profit look considerably better than the underlying trading improvement alone. The board asked for both figures side by side thereafter, which is the sensible illustrative habit.
Watch out
Common mistakes.
- Assuming a stored loss will eliminate all future tax, when annual limitations usually mean some tax is payable even with a large carryforward.
- Recognising a deferred tax asset in full without a supportable forecast of future taxable profit, which auditors will challenge.
- Valuing an acquisition target's tax losses at face value, ignoring change-of-ownership restrictions that may cancel most of them.
Questions
People also ask.
How long can losses be carried forward?
Many regimes now allow them indefinitely, but older rules and some countries impose limits of five to twenty years, so the applicable law and the year of origin both matter.
Why do some companies show no deferred tax asset despite large losses?
Because management cannot yet demonstrate that future profits will be sufficient, so the asset is not recognised or is offset by a valuation allowance.
Is a carryforward better than a carryback?
A carryback delivers cash sooner, but a carryforward can be worth more if future tax rates are higher or if no prior year tax was paid to reclaim.
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