Businesses come up against many pieces of financial and legal jargon when conducting their operations. One especially common term is “carryback.” Understanding what it means and how it functions legally is essential when grasping the intricacies of business finance.
What Is Carryback?
Carryback is a legal term that is used to describe the legal concept of net losses being attributed to past tax years. In this process, the total amount of net losses for a particular year are “carried back” to the previous tax year. Thus, the losses from one year can be used to lessen the taxes to be paid during the previous year.
How Does Carryback Work?
In order for a business to receive a tax refund under a carryback, three conditions must be met. The first is that the current year’s losses must be at least $2000. Secondly, the losses must be greater than the business’s income in the year they are attempting to carry back to. Last, the carryback net operating loss must be used in the immediately previous two tax years.
Why Use Carryback?
Using carryback can be beneficial to businesses as it allows them to use losses from the current year to lessen taxes paid in the past. In a way, it can be seen as getting a payment from the IRS. Ultimately, this can be an effective way to improve a company’s liquidity.
An Example of Carryback in Action
Let us take a look at an example of carryback in action. Imagine that Company A has experienced a large net operating loss of $150,000 USD in 2020. This loss is greater than the company’s income of $120,000 in 2019. As such, Company A can carryback its $150,000 net operating loss to 2019 and receive a refund from the IRS in return.
In Summary
Carryback is a legal concept of net losses being attributed to past tax years. It can be advantageous to businesses since it allows them to receive payments from the IRS in return for their losses. Businesses must meet certain criteria to take advantage of carryback, but doing so is an effective way to improve liquidity.