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NOL Tax Loss Carryforward

Using prior losses to lower future taxes

What is an NOL / Tax Loss Carryforward?

A Tax Loss Carryforward (also called a Net Operating Loss NOL carryforward) is a mechanism firms can use to carry forward losses from prior years to offset future profits and therefore lower future income taxes.  The way a Tax Loss Carryforward works is that a schedule is generated to track all cumulative losses, which are used in future years to reduce profits until the balance in the TLCF is zero. An NOL carryforward schedule is commonly used in financial modeling.

 

Tax Loss Carryforward theme

 

What is the purpose of a Tax Loss Carryforward?

Tax Loss Carryforwards exist so that the total lifetime taxes for a firm will, in theory, be the same no matter how their profits and losses are spread out.

Example if firms could NOT carry forward losses:

A company that had a loss of $10 million in 2018 and a profit of $10 million in 2019 with a 30% tax rate would pay zero tax in 2018 and $3 million in 2019. It’s total profit before tax in 2018 and 2019 combined was zero, yet it paid $3 million in taxes.

Compare that to a different company that also had $0 of profit in 2018 and $0 of profit in 2019.  This company would pay zero taxes and had a total pre-tax profit of $0.

So why would the first company pay $3 million in taxes while the second company paid none?  The first company is much worse off, due to the distribution and timing of its profits.

To address this issue, tax loss carryforwards were created.

 

Building a Tax Loss Carryforward Schedule

The easiest way to keep track of a TLCF schedule is to create a model in Excel.  In the screenshot below, you can see how a financial analyst creates the schedule.

 

Schedule to carry forward losses

 

Steps to create a tax loss carryforward schedule in Excel:
  1. Calculate the firm’s Earnings Before Tax (EBT) for each year
  2. Create a line that’s the opening balance to carry forward losses
  3. Create a line that’s equal to the current period loss, if any
  4. Create a subtotal line
  5. Create a line to calculate the loss used in the period with a formula stating that “if the current period has taxable income, reduce it by the lesser of the taxable income in the period and the remaining balance in the TLCF”
  6. Create a closing balance line equal to the subtotal less any loss used in the period
  7. Next period’s opening balance equals last period’s closing balance

 

Example Tax Loss Carryforward

Below is a screenshot of a tax loss carryforward schedule built in Excel. This is taken from CFI’s e-commerce/startup financial modeling course in which the company has the ability to carry forward losses due to the significant losses expected to be incurred by the business in its first few years of operation.

 

Tax Loss Carryforward - NOL Carryforward Example in Excel

 

The best way to learn how to build a TLCF is by practicing.  By using the example provided, you can see how it was designed and test yourself to create your own in Excel.  If you want a completed example to work with, check out CFI’s financial modeling templates library of completed models from beginner to advanced.

 

IRS Net Operating Loss NOL Carryforward

The Internal Revenue Service (IRS) classifies a tax loss at Net Operating Loss (NOL) and has specific rules about how to perform a Net Operating Loss NOL carryforward.

According to the IRS, it’s very important to keep good records.  Specifically, you should maintain complete records for all tax years that incur a Net Operating Loss for at least 3 years after the NOL carryforward has been used.

To learn more read the details from the IRS NOL carryforward guidelines https://www.irs.gov/publications/p536.

Always consult a professional tax advisor before fining any tax forms.

 

 

Additional resources

Thank you for reading this guide to tax losses, the NOL carryforward process, and how they can be useful when building a valuation model. To keep learning and progressing your career, these additional resources will be helpful:

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