Can Excess Taxable Income Be Carried-Forward? Avoid this Mistake + FAQs

No – U.S. tax law does not allow you to carry forward “excess taxable income” to future years; only unused losses or certain tax deductions/credits can be carried over to reduce future taxable income.

According to a 2023 Tax Foundation analysis, business owners face complex loss limitation rules – 13 states still cap net operating loss use at pre-2018 levels, and 12 others limit carryforward years or amounts.

Misunderstanding these rules can mean losing thousands in tax savings or even IRS penalties for filing an incorrect return. In this in-depth guide, we’ll demystify how carryforwards work for individuals, businesses, and other entities, and how to avoid costly mistakes in handling excess income and losses.

• Why “excess income” itself can’t be carried forward – and what can be carried over.

• Carryforward rules for individuals (capital loss limits, net operating losses (NOLs), charitable deductions) and how they differ from income deferrals.

• How businesses (C-corps, S-corps, partnerships, LLCs) utilize NOL carryforwards, unused credits, and other tax carryovers under IRS and state rules.

• Key terms & IRS forms explained (NOL, excess business loss, carryback vs carryforward, Form 461, Form 1045, Form 3800, etc.) with real examples and court-tested principles.

• Common pitfalls and FAQs – like forgetting a carryforward, differences in federal vs state carryover laws, and what happens during mergers, trust terminations, or ownership changes.

Direct Answer: Can Excess Taxable Income Be Carried Forward?

In plain terms, no, you generally cannot carry forward taxable income itself to another year. The U.S. income tax system operates on an annual accounting principle – each tax year stands on its own.

If you have taxable income in Year 1, you must report and pay taxes on it for that year. You cannot “save” income for a future year to avoid taxes; there’s no concept of “carrying over” income simply because it’s “excess.” The tax code only permits carryforwards for certain unused tax benefits – typically losses or credits that exceed limits in the current year.

The IRS explicitly allows net operating losses (NOLs) (which result from more deductions than income) and some unused deductions/credits to carry over, but not positive taxable income.

Think of it this way: if you earn extra income this year, you’ll pay tax on it this year. If you have a loss this year (negative taxable income), that loss can potentially carry forward to offset income in future years.

The tax law draws a sharp line: income is taxed when earned, whereas defined losses or unused deductions can get relief via carryforwards. The rationale is that losses and certain deductions are given a chance to be used later (so you’re taxed on average income over time), but there is no provision to defer tax on surplus income by moving it to another year.

Important: Don’t confuse deferring income with carryforwards. Some specific situations let you defer recognition of income (for example, contributing to a retirement plan or doing a like-kind exchange delays recognizing gain), but those are special cases and not a general “excess income carryforward.” In all typical scenarios, excess taxable income cannot be carried ahead – only excess losses or credits can.

Key Tax Terms and Concepts 🔑

To navigate carryforward rules, it’s crucial to understand the terminology. Here are key terms and concepts, along with how they relate to carrying amounts between tax years:

• Taxable Income: This is your net income after all deductions in a given year that’s subject to tax. If this number is positive, you generally pay tax on it in that year. If it’s “excess” (i.e. higher than expected), you still report it in the current year – there’s no mechanism to push taxable income itself into later years.

• Net Operating Loss (NOL): When your deductions exceed your income in a year, you have a net operating loss – effectively negative taxable income. Tax law lets you carry forward NOLs to offset future income. For example, if your business had a loss creating a $(50,000)$ NOL in 2024, you can apply that loss to reduce taxable income in 2025 or later. Under current federal law, NOLs arising in post-2020 years can only be carried forward (no carryback) and can offset up to 80% of taxable income in the carryforward year. (Prior to 2018, NOLs could be carried back 2 years or forward 20 years with no 80% cap.) NOL carryforwards are a key way to smooth income over time so a bad year’s loss can relieve tax in good years.

• Carryforward (Carryover): A tax carryforward means using an unused deduction, loss, or credit in a later tax year. This is a broad term for any tax attribute allowed to survive beyond the year it arose. Carryforwards exist for NOLs, capital losses, charitable contributions, tax credits, etc., each with specific rules. A carryback, by contrast, applies a loss/credit to a prior year (to get a refund for past taxes paid). Currently, carrybacks are mostly disallowed for federal purposes (with a few exceptions like some farm losses or credits), emphasizing carryforwards as the primary mechanism for relief.

• Excess Business Loss (EBL): A limitation for non-corporate taxpayers (individuals, LLCs, S-corps via owners) that caps the amount of business losses you can use in a year. For 2023, a joint filer can’t deduct business losses over about $578,000 (or ~$289,000 for singles; this threshold adjusts annually). If your business losses exceed this, the excess is not deductible in the current year – instead, it’s treated as an NOL carryforward to next year. That excess loss converts into an NOL, meaning you carry it forward under NOL rules (subject to the 80% rule in future years). This rule, introduced by the Tax Cuts and Jobs Act and amended by the CARES and Inflation Reduction Acts, applies for tax years 2021 through 2028 (it was suspended for 2018–2020). The excess loss converts into an NOL, meaning you carry it forward under NOL rules.

• Capital Loss Carryover: If you have investment losses (e.g. stock sales) that exceed the annual limit you can deduct, the leftover loss is a capital loss carryforward. For individuals, you can deduct capital losses against capital gains in full, plus up to $3,000 of excess loss against other income per year (or $1,500 if married filing separately). Any losses beyond that $3,000 limit are carried forward indefinitely until used. For example, if you incurred a $10,000 capital loss and only $3,000 is deductible this year, the remaining $7,000 carries over to next year (and you can again use up to $3k, etc.). The carryforward retains its character (e.g. it can still offset future capital gains in full). Corporations, on the other hand, cannot deduct any net capital loss against ordinary income – a corporate capital loss can only offset capital gains. A corporation’s unused capital losses are carried back 3 years and/or forward 5 years as short-term losses.

• Unused Tax Credits: Various tax credits (which directly reduce tax liability) have carryforward provisions. For instance, general business credits (a category including R&D credit, investment credits, work opportunity credit, etc.) can usually be carried back 1 year and forward 20 years if not fully used. If you don’t have enough tax liability to use the credit this year, you can apply it in future years’ returns. Foreign tax credits (for taxes paid to foreign countries) can be carried back 1 and forward 10 years. Not all credits carry forward – some personal credits (like the child credit) are use-it-or-lose-it – but many business and investment-related credits do. It’s critical to check each credit’s rules; IRS Form 3800 helps track many carryforwards of business credits.

• Carryforward vs. Income Deferral: Note that carrying forward a loss or credit is different from deferring income. Deferring income means arranging so that income is recognized in a later year (for example, delaying an invoicing until January so payment is taxed next year). That’s a timing strategy, not a statutory carryforward. The tax code prevents most attempts to simply defer earned income without economic basis – accrual-method businesses generally must recognize income when earned, and cash-method taxpayers when received. Without a specific provision (like an IRA or installment sale rules), you can’t just choose to report income in a different year. A carryforward, conversely, is explicitly allowed by law for specific items like losses or credits – you’re not choosing to delay them; you’re using a provision to apply them later because you exceeded some limit this year.

Understanding these terms sets the stage. In short: taxable income itself resets each year, but certain negatives (losses, deductions) and excess credits can live on as carryforwards to future tax years. Now, let’s break down how this plays out for different taxpayers and entities.

Carryforward Rules for Individuals (Personal Taxes) 💼

Individual taxpayers can’t carry over ordinary income, but they can carry forward various losses and unused deductions. Here are the main carryforward provisions affecting individuals:

1. Capital Loss Carryforward (Individuals): If you sold investments at a loss, you can use those losses to offset any capital gains realized in the same year, dollar for dollar. If after offsetting gains you still have a net capital loss, up to $3,000 of it can reduce your other income (such as wages) for the year. Any loss beyond $3,000 is not lost – it carries forward to future years indefinitely. You will claim the carryforward on next year’s Schedule D. Each year, the same $3,000 rule applies, so large investment losses may take many years to fully utilize. Example: Alice sells stocks at a $10,000 loss in Year 1 and had no gains. She deducts $3,000 of it against her salary income on her 1040, and carries $7,000 forward. In Year 2, she has $2,000 of capital gains; she uses $2,000 of the carryforward to offset those (paying no tax on the gains), and still has $5,000 loss left. She again deducts $3,000 against her salary in Year 2, leaving $2,000 to carry into Year 3. This continues until the loss is fully used. The key point is individuals can carry capital losses forward forever until exhausted, providing ongoing tax relief for investment losses.

• What to do: Keep track of your capital loss carryover on Form 1040 Schedule D each year. Tax software and CPAs will roll this over automatically if you provide last year’s info. If you switched tax preparers or software, ensure the new one knows about any carryforward. Forgetting a capital loss carryforward is a common error – it means you’d pay more tax than necessary by not using losses you’re entitled to. Always carry those losses into the next year’s return.

• IRS Forms: Schedule D and the Capital Loss Carryover Worksheet in the Schedule D instructions help calculate how much loss is used and how much goes forward. There’s no separate form to elect a carryforward – it happens by default under the law if you have leftover loss.

2. Net Operating Loss (NOL) Carryforward (Individuals): An individual can have an NOL typically due to losses from a sole proprietorship, farm, rental properties, or other business activities (or casualty losses). Essentially, if your business deductions and other allowed deductions exceed all your income, you have a negative taxable income. Under today’s rules, you cannot carry back an NOL arising after 2020 – you may only carry it forward to future years. The NOL will be available to deduct against income in those future years, potentially reducing your taxes then. However, for NOLs arising in 2018 and later (except 2018–2020 which had temporary rules), you can only use the NOL to offset up to 80% of your taxable income in the carryforward year. Any remaining NOL carries forward again to subsequent years, indefinitely, until used up. (If you have older NOLs from pre-2018, those carryovers are not subject to the 80% rule and still reduce 100% of income, and they keep their original 20-year lifespan limit.)

• Example: John is a sole proprietor who had a very bad year in 2023: his business lost $100,000, and even after other income and deductions, he ended up with a taxable income of –$50,000 (a $50k NOL). He carries that $50k NOL forward to 2024. In 2024, his business rebounds and he has $60,000 of taxable income before NOL. Under the 80% rule, John can use the NOL to offset up to 80% of $60k, which is $48,000. So he deducts $48k of his NOL in 2024, cutting his taxable income to $12,000, and pays tax only on that. He’ll carry forward the remaining $2,000 of NOL to 2025. In 2025, he can deduct that final $2k (again up to 80% of that year’s income). If John had an NOL from 2017, prior law would have let him carry it forward up to 20 years without an 80% cap, or even carry it back to get a refund from a prior year. But now, it’s forward-only for most. Bottom line: individuals can carry forward business losses (NOLs), but there are limits on usage each year.

• Excess Business Loss tie-in: If John’s loss was extremely large, the excess business loss rule might have capped how much of it he could even claim in 2023. For example, if John (single) lost $600,000 in 2023, the tax code would disallow anything over ~$289,000 for that year (threshold for singles). Say the threshold is $289k – John could claim $289k of his loss in 2023 to offset other income (or to produce an NOL of $289k if no other income), but the remaining $311,000 loss would be an “excess business loss.” That excess portion is not usable in 2023; instead, it is carried forward as part of an NOL to 2024. So John’s 2024 NOL carryover would include that $311k (subject to the 80% rule in 2024). This shows how the excess loss limitation essentially forces very large losses into future years as NOLs.

• IRS Forms: Individuals use Form 461 to compute any excess business loss that gets carried forward as NOL. To claim an NOL deduction in a carryforward year, you’ll typically enter it on the “Other Income” line (as a negative number) of Schedule 1 (Form 1040) and attach a statement. IRS Publication 536 provides the worksheet to calculate your NOL and track carryovers. If you had the option to carry back (for older NOLs or certain eligible farming NOLs which still have a 2-year carryback), you’d use Form 1045 or Form 1040-X to claim a refund, but for carryforwards, you just deduct it going forward – no special form to file an election (except if you elect to waive a carryback when it was allowed).

3. Charitable Contribution Carryforward: Individuals have annual limits on charitable donation deductions (60% of adjusted gross income for cash to public charities, 30% for certain other gifts, etc.). If you donate more than the limit allows in one year, the excess charitable deduction carries forward up to 5 years. For example, if your AGI is $100k and the max deductible this year is $60k but you donated $80k, you carry $20k forward to next year (as a contribution carryover). Next year, you can deduct that carryover plus new donations, subject again to that year’s AGI limit. After 5 years, any unused charitable carryforward expires. The rules ensure large multi-year pledges can still be deducted over time. Keep records of carryforwards on IRS Form 8283 (for non-cash donations) and note carryovers on Schedule A instructions worksheets.

4. Other Individual Carryforwards: A few other items for individuals: Foreign Tax Credit carryover (if you paid foreign taxes that you couldn’t fully credit due to limits, you can carry forward for 10 years). Alternative Minimum Tax (AMT) credit – if you paid AMT in the past, you get a credit to carry forward to regular tax in future years (AMT credits carry forward indefinitely until used). Also, if you have a 401(k) or IRA excess contribution (not exactly “taxable income” but an excess deferral), you can carry it to next year in the sense of applying it against that year’s limit (though it may be taxable in the current year as a penalty). These are specialized, but worth noting as “carryover” concepts affecting individuals.

What Individuals Cannot Carry Forward: It’s equally important to note what you cannot carry forward as an individual. You cannot carry forward unused portions of the standard deduction or personal exemptions (those reset each year).

You also can’t carry over unused itemized deductions in general (other than the specific ones like charitable mentioned). For instance, if you paid a lot of mortgage interest one year, you deduct what you paid – if it results in no taxable income, you don’t get to carry any “excess deductions” beyond an NOL. (However, one quirky exception: in the final year of an estate or trust, excess itemized deductions can pass out to beneficiaries – see Trusts section below).

Similarly, credits like the Child Tax Credit or Education Credits that you didn’t use (maybe because you had no tax) are not carried forward – if refundable, you’d get a refund, if non-refundable, any excess just vanishes for that year (though some credits like the Lifetime Learning Credit you can just claim again in a future year if you have qualifying expenses again, but you can’t carry the unused portion from a prior year). Always verify whether a specific deduction or credit has a carryforward – don’t assume you can roll it over unless the tax code says so.

Carryforward Rules for Businesses (C-Corporations) 🏢

C corporations (regular corporations subject to corporate income tax) have their own set of carryforward provisions. A corporation computes taxable income similarly – if it ends up with a loss, it’s called an NOL and can be carried over. If it has unused credits or excess deductions, similar concepts apply. Here’s how it works:

1. Net Operating Loss (NOL) – Corporations: Corporate NOL rules parallel individual NOL rules in many ways. Under the Tax Cuts and Jobs Act (TCJA) changes, corporate NOLs arising in 2018 and later can be carried forward indefinitely (no expiration), but can only offset 80% of taxable income in a given carryforward year.

The carryback of corporate NOLs was eliminated starting 2018 (except a temporary revival for 2018–2020 under the CARES Act, and still available for certain farming losses). Pre-2018 NOLs on corporate books remain subject to the old rule (2-year carryback, 20-year carryforward, no 80% cap). For most current purposes, a corporation that incurs a loss will simply carry it to future profitable years.

• Example: XYZ Corp has a taxable loss of $1 million in 2024 (so an NOL of $1M). In 2025, it earns $800,000 taxable income. Under the 80% rule, XYZ can use $640,000 (which is 80% of $800k) of the NOL to offset its 2025 income. XYZ pays corporate tax on the remaining $160,000 of income. The leftover NOL ($1,000,000 – $640,000 = $360,000) carries forward to 2026. If XYZ never returns to profitability, the NOL carryforward simply stays unused (there’s no value unless there are profits to absorb it). However, unlike individuals, corporations don’t have an “excess business loss” limitation – they can take the full loss in the loss year (which just results in the NOL) without a separate cap. The 80% limitation applies when using the NOL later.

• Ownership changes – Section 382: One wrinkle for corporate NOLs is that if the company has a significant ownership change (generally, more than 50% change in stock ownership by value), Section 382 of the tax code imposes a limit on using NOLs after that change. Essentially, the corporation’s NOL carryforwards from before the change can only be used up to a yearly amount equal to the company’s value at the change date multiplied by a federal interest rate (a rate around 4-5% often). This prevents corporations from being bought just for their loss carryforwards. For example, if a loss corporation worth $1 million is acquired, and the IRS rate is 5%, the new owner can only use up to $50,000 of those NOLs per year going forward (plus any unused portion rolls over). If the company was effectively a shell, the losses largely die off over time under this rule. Important court cases and IRS regs enforce this anti-“loss trafficking” rule, stemming from experiences like the Libson Shops case decades ago. So for corporations, NOL carryforwards are valuable, but they can be restricted if the company’s ownership or line of business changes significantly.

• Filing: Corporations claim NOL carryforwards on Form 1120 (the corporate tax return) by simply subtracting the NOL deduction on the appropriate line (Schedule K of Form 1120 tracks NOL deductions). There used to be a Form 1139 for quick refunds via carryback, but with carrybacks gone in most cases, now it’s all forward. Corporations should keep detailed schedules of each year’s NOL and usage, especially if any Section 382 event occurs.

2. Capital Loss Carrybacks/forwards – Corporations: Unlike individuals, a corporation cannot deduct a net capital loss against ordinary income at all. If a C-corp’s capital losses exceed its capital gains in a year, it produces a net capital loss.

The corporation can then carry that net capital loss back 3 years and/or forward 5 years to offset capital gains in those years. It always applies to the earliest year first. Any remaining after 5 years expire. Additionally, any capital loss carryover for a corporation is treated as short-term, regardless of whether the loss was short or long term originally. For example, if Acme Corp has a $100k capital loss in 2025 and no gains that year, it can amend or adjust its 2022, 2023, or 2024 returns (carryback) if it had capital gains in those years, to get a refund by applying this loss. If not, it carries forward to 2026–2030 (five years) to use against any capital gains in those years. This is one area corporations actually have a carryback available (capital losses), whereas individuals do not have a carryback for capital losses (individuals just carry forward).

• If a corporation still has unused capital loss carryover after 5 years, it expires worthless. Corporations must carefully plan selling appreciated assets if they have expiring losses – e.g., try to realize some gains before the loss carryover deadline so it can be used.

• Tax forms: Corporations show capital losses on Schedule D of Form 1120. The carryback claim can be made using Form 1139 (Corporate Application for Tentative Refund) or by amending returns for the carryback years. Carryforwards are automatically applied in future years’ calculations of taxable income (the corporation will attach a schedule of capital loss carryovers to its return).

3. Business Tax Credit Carryforwards: Corporations (and other businesses) often have unused tax credits that carry forward.

Common examples: – General Business Credits: This is a collection of credits (R&D credit, investment credit, work opportunity credit, etc.). If these credits exceed the tax liability in the year earned, the excess doesn’t vanish – typically, you can carry back 1 year and forward 20 years. After 20 years, any still-unused credit expires. Many large companies accumulate such credits (especially R&D) and use them over many years as they become profitable.

For instance, a biotech startup might generate R&D credits during years it has no tax (because of losses); those credits carry forward up to 20 years to offset taxes when the company becomes profitable. It’s important to track the start-year of each credit to know when the 20-year clock ends. – Minimum Tax Credit (MTC): For corporations, the corporate AMT was repealed in 2018, and any remaining AMT credits from prior years became refundable over 2018-2021. So after 2021, C-corps no longer have AMT credits to carry. – Foreign Tax Credit (corporate): Similar to individuals, corporate foreign tax credits can carry over (back 1, forward 10). – Alternative Fuel/Energy Credits: Some of these have specific carryforward rules – for example, if a credit isn’t fully used because of limitations, often they can carry to future years.

4. Interest Deduction Carryforwards (Section 163(j)): The TCJA introduced a limit on business interest expense deductions for large businesses. Generally, interest expense is limited to 30% of adjusted taxable income (a proxy for EBITDA) for businesses with gross receipts over $27 million (2025 threshold) or for tax shelters. If a corporation’s net interest expense exceeds that 30% limit, the excess interest is disallowed for the year – but crucially, it’s carried forward indefinitely. It can be deducted in a future year if there is excess capacity under the 30% limit then. So this is another form of carryforward: disallowed interest carryforward. On the tax return, the corp would report full interest expense but only deduct the allowed portion; the rest becomes an attribute to carry to next year. Each year, you add any new disallowed interest to the carryforward pool. If in a later year the company has low interest or high income (so 30% of ATI is larger than their interest expense), the carryforward can be used to deduct previously disallowed interest. This rule ensures interest that was limited isn’t gone forever – just deferred. Corporations file Form 8990 to compute the limitation and track carryforwards.

5. Charitable Contributions (Corporate) Carryforward: C-corporations can deduct charitable contributions up to 10% of their taxable income (before certain deductions). Any excess contributions can be carried forward 5 years (similar concept to individuals, though individuals have higher percentage limits). Excess carries forward, first-in-first-out basis, and expires after 5 years if unused.

6. Inventory & Other Carryovers: Some other business-specific carryovers: e.g. inventory accounting (if you have a negative taxable income due to inventory write-downs, that’s just part of NOL); capital construction costs (unamortized investment credits from prior law can carry); and if a corporation had an excess charitable deduction (over 10% limit) it carries forward 5 years as noted.

Federal vs. State Differences for Businesses: Most states start with federal taxable income, including after NOL deduction, but then have their own rules for NOLs. Some states do not conform to the unlimited carryforward/80% rule – for instance, 13 states still use the old federal rule: allow NOLs to offset 100% of income but limit carryforward to 20 years. A dozen states allow fewer carryforward years (e.g. 5, 10, or 15 years). A couple of states have unique caps (Pennsylvania historically limited NOL usage to a percentage of income; New Hampshire capped the dollar amount of NOL usable). A few states, like Illinois (for a time) and California (for 2020-2022), temporarily suspended NOL usage when budgets were tight – meaning businesses could accrue NOLs but not use them until the suspension lifted. Some states still permit NOL carrybacks even though federal doesn’t (e.g. Idaho, Mississippi, Missouri, New York, Montana allow some form of NOL carryback for state taxes). The variation is considerable. So a C-corp might find that on its state tax return, it can only carry an NOL forward X years or use a different percentage. State rules for credit carryforwards and interest limits may also differ (some states didn’t adopt the interest limitation at all; others did with tweaks). The key is that for federal taxes, the rules are uniform, but always check your state’s stance – state tax law might require separate tracking of carryforwards. Many states require adding back the federal NOL, then applying their own NOL deduction, etc., so it gets complex.

Pass-Through Entities: Partnerships, LLCs, and S Corporations 🤝

Partnerships and S-corporations are pass-through entities, meaning they generally do not pay income tax at the entity level (with some exceptions at state levels or special federal circumstances). Instead, income, deductions, and credits “pass through” to the partners or shareholders, who report them on their personal or corporate returns. As a result, carryforward rules for partnerships and S-corps often operate at the owner level, not the entity. However, there are important nuances:

1. Partnerships (including LLCs taxed as partnerships): A partnership itself doesn’t carry forward losses like a corporation would, because it allocates all income and loss to partners each year. However, a partner might not be able to use the loss immediately due to various limitations (basis, at-risk, and passive loss limits). In such cases, the unused losses are suspended and carried forward on the partner’s own tax records.

• Basis and At-Risk Limitations: A partner can only deduct losses up to the amount they have invested or are at-risk for in the partnership. If the partnership allocates a loss of $50k to a partner who only has $30k of basis (investment) in the partnership, the extra $20k is not deductible in that year. That $20k becomes a carryforward (suspended loss) that the partner can use in future years when they have sufficient basis (for example, if they contribute more capital or if the partnership earns income, increasing their basis). This carryforward isn’t an “NOL” in the sense of a separate deduction on a return, but it’s tracked on the partner’s form K-1 and Form 7203 (for S-corp basis) or similar records, to be used later.

• Passive Activity Losses: If the partner is not materially participating in the business (e.g. a limited partner or an LLC member who’s not active), the loss might be considered passive. Passive losses can only offset passive income. Any passive loss not allowed (due to lack of passive income) is carried forward indefinitely until the taxpayer either generates passive income in future years or disposes of the activity entirely (at which point all suspended losses become deductible in full). For example, a partner in a rental real estate partnership (passive activity) might have losses each year that are disallowed because they have no other passive income. Those losses carry forward year after year. When they sell their partnership interest or the partnership sells the property, the accumulated losses are released and can be deducted. These passive loss carryforwards are tracked on Form 8582 for individuals. They remain with the taxpayer (not the partnership) since it’s part of the partner’s own tax situation.

• Partnership NOL? Partnerships don’t compute NOLs at the entity level – if a partnership’s deductions exceed its income, it just passes through a net loss to partners, who then determine if they have an NOL on their personal return. The partnership doesn’t carry anything forward; the partner does via their NOL or suspended losses. As IRS Pub 536 notes, “Partnerships and S corporations generally cannot use an NOL. However, partners or shareholders can use their share… to figure their individual NOLs.”

• Section 163(j) Interest – Partnerships: This is a special case. Under the business interest limitation (§163(j)), a partnership calculates how much interest is deductible at the partnership level. If some interest is disallowed, that excess business interest expense (EBIE) is allocated to the partners, but the partnership also passes out something called Excess Taxable Income (ETI) in future years if it has room under the limit. The rules are tricky: an individual partner cannot deduct the EBIE carryforward until they receive an allocation of excess taxable income from that same partnership in a later year. In essence, the disallowed interest is stuck at the partner level, carried forward indefinitely, but can only be freed up when the partnership has “excess taxable income” (i.e. taxable income in a year that didn’t go toward deducting interest). ETI is like unused capacity. For example, Partnership AB in 2023 had to disallow $10k of interest (allocated to Partner A $5k, Partner B $5k). In 2024, AB has very low interest and lots of income, resulting in “Excess Taxable Income” of say $50k. That ETI is allocated to A and B. When A gets, say, $25k of ETI allocated on the K-1, it allows A to deduct that previously suspended $5k of interest (now “unlocked”). If A doesn’t get ETI allocations, the $5k stays suspended forever or until the partnership is sold/liquidated (at which point any remaining EBIE may possibly go away unused – in a sale, a partner can increase their stock basis by the amount of suspended EBIE, essentially giving some benefit). Partnerships must report these figures on Schedule K-1.

• Summary: A partnership doesn’t pay tax or carry losses itself, but its partners effectively carry forward any losses they couldn’t use (due to basis, at-risk, passive, or 163(j) limits). It’s critical for owners to track their suspended losses and carryforwards from pass-through investments. That responsibility falls on the taxpayer (though the K-1 provides info like how much loss was allocated, how much is allowed vs disallowed, etc.). Tools like tax software or a CPA’s worksheet come in handy to keep these straight year to year.

2. S Corporations: S-corps are similar to partnerships in that income and loss flow through to shareholders. An S-corp does not carryforward losses at the entity level. If an S-corp has a loss, each shareholder gets their share of that loss on their K-1. The shareholder can deduct it against other income only if they have sufficient stock (and loan) basis and are not limited by passive rules.

• If a shareholder lacks basis (e.g. the loss exceeds their investment in the company), the excess loss is suspended and carried forward for that shareholder until they have more basis (like by contributing capital or the company earning profits). This is akin to the partnership basis limit. The suspended loss will be allowed in a future year when basis is restored. Shareholders track this on Form 7203 (S Corp Shareholder Stock and Debt Basis Limitations).

• Passive loss rules also apply to S-corp shareholders who don’t materially participate (just like partnership passive losses – suspended and carried forward).

• S-corps are subject to the same excess business loss (EBL) rule at the shareholder level – meaning a huge pass-through loss could be limited and turned into an NOL carryforward on the shareholder’s return.

• For interest expense limitation (163(j)), as mentioned, the S-corp itself determines if interest is limited. If so, the disallowed interest is not passed out as a fixed amount to shareholders like in a partnership; rather, it stays at the S-corp. The S-corp will carry it forward (off books, on a worksheet) to the next year. It will report to shareholders any “Excess taxable income” or “Excess business interest income” that can enlarge their personal 163(j) limits. Shareholders don’t directly carry an “EBIE” from an S-corp year to year – it’s handled by the S entity. This is a subtle difference from partnerships but important. Practically, most small S-corps are exempt from 163(j) if under the gross receipts threshold, but larger ones must file Form 8990 and track it.

• QBI Deduction Note: S-corp (and partnership) income may qualify for the 20% Qualified Business Income deduction. That’s taken at the owner level and has no carryforward – if you can’t use all of a QBI deduction (due to taxable income limits), it doesn’t carry over.

3. Trusts and Estates (as pass-throughs): While not typically labeled “pass-through” like partnerships, trusts and estates can distribute income to beneficiaries and have some unique carryover provisions. We’ll cover them next, but note that complex trusts/estates can also generate NOLs and carryforwards similar to individuals.

Trusts and Estates: Special Carryforward Rules 🏛️

Trusts and estates (fiduciary entities) are taxable entities that in some ways act like individuals, but with the ability to distribute income to beneficiaries. They have a couple of unique carryforward scenarios:

1. Net Operating Loss (Trust/Estate): Like any taxpayer, a trust or estate can incur an NOL if deductions (including distributions to beneficiaries, which are deductible to the trust) exceed income. This might happen if, for example, an estate has administrative expenses or a trust has a big depreciation deduction with little income. The NOL carryforward rules for trusts/estates mirror individual rules – they can carry an NOL forward (and back when allowed) under Section 172.

For instance, a complex trust that accumulates income could have an NOL in 2022 and carry it to 2023 to offset income. One difference: because trusts have a limited lifespan, if the trust or estate terminates, you need special handling (see next point). As long as the trust/estate exists, it uses its NOL like an individual would.

2. Capital Loss and Final Year Deductions – Passing to Beneficiaries: Normally, a trust or estate also has the $3,000 capital loss deduction limit per year (just like individuals) and carries over excess capital losses year to year internally. However, upon termination (when the trust or estate is closing and distributing all assets), any unused capital loss carryover and NOL carryover can be transferred to the beneficiaries who succeed to the property.

In other words, nothing gets lost when the entity ends – the beneficiaries step into the shoes. For example, suppose a trust had a $10,000 capital loss carryover. In its final tax return, it can’t use it (no income left), but the beneficiaries will each get a share of that carryover on their personal returns (pro rata to their distributions).

They then use it on their own Schedule D going forward. The tax regulations say the carryover is “the same in the hands of a beneficiary as in the estate or trust”. Similarly, an NOL carryforward of the trust would transfer and the beneficiaries treat it as their NOL (usually in the next year).

• Additionally, excess deductions (deductions in the final year that exceed the trust’s final year income) can pass out to beneficiaries as a miscellaneous itemized deduction (under Section 642(h)). This isn’t a carryforward per se (it’s taken on the beneficiary’s current return), but worth noting as a “use it at end” rule.

• Practice point: If you’re a beneficiary receiving such carryovers, you’d get a statement from the fiduciary or it will be on the final Schedule K-1 (often there’s a code on fiduciary K-1 for “section 642(h) carryovers”). You then claim the carryover on your own returns going forward.

3. Charitable contribution carryover: Trusts also have charitable deduction limits (usually tied to gross income). Any excess charitable contributions by a trust may carry forward 5 years (for trusts that aren’t simple passthroughs of the charitable deduction). However, many trusts distribute income or pay it out, so this is less common.

4. State differences: States often follow similar principles for trusts but since many smaller trusts pay no tax (distribute all income), carryovers mostly matter for estates or complex trusts that temporarily accumulate income.

Overall, trusts and estates abide by the standard carryforward rules but have that termination year transfer provision so that beneficiaries aren’t penalized by unused losses. This is a bit of a hybrid of entity and pass-through treatment.

Federal vs. State Carryforward Differences 🌎

We’ve touched on state differences in context, but let’s summarize key variances between federal and state rules on carryforwards:

• Net Operating Loss (NOL): Federally, post-2017 NOLs = infinite carryforward, 80% usage limit, no carryback (except temporary 5-year carrybacks for 2018-20 under CARES, now lapsed, and 2-year for farm NOLs). States, however, have a patchwork:

  • Some states did not adopt the 80% cap or indefinite carryforward. For example, before recent changes, California limited carryforwards to 20 years and had no 80% cap (i.e. you could offset 100%) – in fact, CA temporarily suspended NOL usage for 2020-2022 for larger businesses, and extended the carryforward period accordingly. New York generally conforms to federal now (no NOL cap, indefinite for corporate tax, but they allowed a 3-year carryback up to certain limits).

  • Pennsylvania (for corporate tax) historically allowed 20-year carryforward but capped the deduction to a percentage of taxable income (it was 40% for some years, though PA recently moved to 80% to align with federal).

  • Illinois allows NOL carryforward 12 years, unlimited amount. Nevada, Washington, Texas have no income tax or use gross receipts taxes, so NOLs are moot there.

  • Many states have shorter carryforward periods: e.g., Massachusetts 20 years, New Jersey 20 years, Michigan 10 years, Arkansas 8 years, Rhode Island 5 years.

  • Also, some states treat NOLs differently for individuals vs corporations. For example, some states that tax individuals might disallow NOLs entirely or limit them, while states taxing corporations might allow full NOL usage.

• Capital Losses: States often conform to the federal $3k loss limit for individuals because they use federal taxable income as a baseline. But not all – a few states might not allow the $3k deduction or might have their own calculation. For corporations, if a state doesn’t allow carrybacks (most states don’t allow separate state carryback claims), a corporation might only carry capital losses forward for state purposes. This can get complex with multi-state apportionment.

• Credits: State tax credits are separate from federal and have their own carryforward rules. But in terms of federal credits on state returns: usually irrelevant, since state returns don’t use federal credits (except foreign tax credit in context of states that tax worldwide income may allow a similar credit). Businesses often have to track state NOL carryforwards separately from federal – they can differ in amount due to different starting incomes or nonconformity.

• Excess Business Loss (EBL): Not all states adopted the excess business loss limitation for individuals. Some states still allow full loss deductibility (which means on the state return you might not have to carry forward – you’d use it all in that year). Others did adopt it, which means your state NOL could differ from federal.

• Section 163(j) interest: Many states initially decoupled from this limitation to avoid complexity for small businesses, but some have since conformed. If a state doesn’t have the interest limit, then there’s no disallowed interest to carry forward for state purposes (while there might be for federal). If a state does conform, the amount of disallowed interest carryforward could be different because state ATI and state calculations can vary.

• Final year trust/estate deductions: Some states allow beneficiaries to take those carryovers, some might not – but usually they do if they follow federal 642(h).

• Terminology: States might use different forms. Always consult state instructions.

The takeaway is state tax law can be “stingier” or occasionally more generous with carryforwards. Never assume your federal carryover amount works the same on your state return. You might have to adjust or track them separately. For example, in a high-tax state with no NOL, an individual with a big business loss might pay no federal tax (thanks to an NOL), but still owe state tax despite no carryover – that person would still owe significant state tax. Plan liquidity for such differences.

Real-World Examples and Scenarios 📊

Let’s illustrate common carryforward scenarios in practice, to solidify how these rules play out:

Scenario 1: Individual Investor with Capital Loss
Jane sold some stocks at a significant loss. In 2024 she had $10,000 in capital losses and no capital gains. She also earns $50,000 in salary. Federal tax rules let her use $3,000 of the loss to offset her salary income, reducing taxable income. The remaining $7,000 loss becomes a carryforward to 2025. In 2025, Jane has $2,000 of capital gains from selling mutual funds, plus her salary. She uses $2,000 of the carried loss to offset those gains fully (so no tax on the gains). That leaves $5,000 of loss carryover. She again deducts $3,000 against her salary in 2025, leaving $2,000 to carry into Year 3. Now in 2026, assume Jane has no gains and no further losses. She will deduct $2,000 (of the carryover) against her salary (staying within the $3k limit), and finally her carryforward is exhausted. This multi-year usage saved her tax each year. If Jane forgets about the carryforward in 2025 and only deducts $3k (not realizing she could also offset her $2k capital gain), she’d pay unnecessary tax on that $2k gain – a mistake to avoid.

Scenario 2: Small Business Owner with NOL
Mike is a sole proprietor of a cafe. In 2023, he has a bad year and ends up with a ($30,000) loss (NOL) on his Form 1040. He has no other income. Because post-2020 NOLs can’t be carried back, Mike will carry this $30k NOL forward to 2024. In 2024, his cafe rebounds and he has $40,000 of profit (before NOL) on his return. He can use his NOL to offset 80% of his 2024 taxable income, which is $32,000. This brings his taxable income down to $8,000, saving him tax on that $32k portion. He then carries the remaining loss forward to 2025. If Mike’s loss had been larger than 80% of 2024 income, he’d carry forward the rest to 2025.

Scenario 3: C-Corporation with NOL and Credits
TechCo Inc. is a C-corp that had heavy R&D expenses. In 2021 and 2022, TechCo had taxable losses, yielding NOLs of $5 million. It also generated R&D tax credits of $200,000 that it couldn’t use (no tax liability due to losses). Fast forward to 2025: TechCo becomes profitable with $3 million taxable income and a tax liability of $630,000 (21% corporate rate). How do carryforwards help?

• NOL usage: Under federal rules, TechCo’s NOLs carry forward indefinitely. In 2025, it can use the NOLs to offset up to 80% of taxable income. 80% of $3,000,000 is $2,400,000. So TechCo deducts $2.4M of its NOL, reducing taxable income to $600,000. It pays tax on that $600k. It carries forward the unused NOL of $5M – $2.4M = $2.6M to 2026.

• Credit usage: TechCo also has that $200k of R&D credit carryforward. After applying the NOL, TechCo’s tax liability was $126k. Generally, credits apply after calculating tax. TechCo can use the R&D credit to reduce that tax. However, credits can’t reduce corporate tax below certain minimums. Assuming it can use $126k of its credits to fully wipe out the 2025 tax, TechCo uses $126k of the $200k credit, leaving $74k credit to carry forward further. It pays $0 tax in 2025 thanks to carryforwards (NOL + credit). It still has $2.6M NOL and $74k credit for future years. This example shows how profitable companies often pay no tax for years when they emerge from a loss period – they have a “shield” from past losses. Carryforwards are a legitimate and common tool: even giants like Tesla had accumulated massive NOLs from earlier losses, which they used to offset recent profits.

Scenario 4: Partnership Losses and Carryforwards
Dr. Smith invests in a medical office partnership as a passive investor. In 2024, the partnership allocates a loss of $20,000 to Dr. Smith, but he can’t deduct it because:

• He only has $10,000 basis in the partnership (he invested $10k; the $20k loss exceeds that). So $10k is disallowed for lack of basis.

• Additionally, he has no other passive income, so even the $10k that could be allowed by basis is suspended by passive loss rules.

• End result: The full $20,000 is a suspended loss for Dr. Smith in 2024.

• These suspended losses carry forward. In 2025, suppose the partnership earns $15,000 income allocable to him. Now he has income to absorb some passive loss, and his basis will increase by $15k (from 10k to 25k). He can use $15,000 of his prior losses to offset that income (so he pays no tax on the partnership income). He still has $5,000 loss carryover remaining. If the partnership dissolves in 2026, any remaining suspended losses become fully deductible. Dr. Smith would claim that $5k on his 2026 return in full.

• Throughout, the partnership itself filed informational returns and passed out losses; it didn’t carry anything on its books year to year (aside from tracking Dr. Smith’s capital account). Dr. Smith carried forward the losses on Form 8582.

Scenario 5: Estate Final Year Carryover
An estate of a deceased person has been in administration for 2 years (perhaps due to complex asset sales). By the final year, the estate has a capital loss carryover of $8,000 (maybe from selling stocks at a loss) and also a $5,000 NOL from a prior year (administrative expenses > interest income). In the final year, the estate distributes all assets to the two beneficiaries and closes. The estate’s final K-1s to the beneficiaries will each report half of the $8k capital loss carryover ($4k each) and half of the NOL ($2.5k each) as carryovers under the applicable regulations. Each beneficiary, on their own next-year tax return, can use these carryovers as if they personally incurred them. So if one beneficiary has capital gains next year, their inherited $4k capital loss will offset those gains; and they can use the $2.5k NOL against their income, subject to the usual limits. This ensures the tax benefit of those losses is preserved.

These scenarios highlight the mechanics: individuals using capital losses over time, businesses using NOLs and credits to zero out taxes, partners carrying forward what they can’t use, and trusts transferring losses at termination. They show why careful tracking and understanding of carryforward rules matter – tax outcomes can span many years.

Pros and Cons of Carryforwards 📈📉

While carryforwards are valuable, they come with both advantages and drawbacks. Here’s a quick summary in a pros and cons format:

Overall, carryforwards are a crucial safety valve in the tax system, but they require careful navigation. The pros generally outweigh the cons if you adhere to the rules and maintain proper documentation, but one should be mindful of the limitations and ensure to actually reap the benefit before expiration.

What to Avoid (Common Mistakes and Pitfalls) ⚠️

Navigating carryforwards can be tricky. Here are common mistakes taxpayers and businesses should avoid:

• ❌ Assuming you can carry forward income or unused standard deductions: Many people ask if they can carry forward “unused income” or the part of standard deduction they didn’t need. The answer is no. Each year’s income stands alone, and deductions like the standard deduction don’t carry over. Only specific excess losses or credits carry forward by law.

• ❌ Forgetting to claim a carryforward: This is perhaps the #1 pitfall. It’s surprisingly easy to forget last year’s carryover if you don’t have continuous records. For example, forgetting a capital loss carryover or a disallowed passive loss carryover when preparing the next return. Tax software usually rolls these over, but if you switch tax preparers or software, data may not transfer. Always review your prior year return for any “carryover” amounts. If you do forget and later realize, you can file an amended return for that year to claim the proper carryforward usage – but note, using a carryforward isn’t optional; it must be used to the extent you’re allowed.

• ❌ Misapplying the 80% NOL rule: Since the TCJA change, a common mistake for those unfamiliar with the rule is to deduct an NOL carryforward against 100% of income, when in fact only 80% is allowed for post-2017 NOLs. Make sure to calculate correctly. If you had both pre-2018 and post-2018 NOLs, the computation is even more complex. Failing to apply this can lead to IRS notices or audits adjusting the NOL usage.

• ❌ Not tracking expiration dates: Some carryforwards expire after a period. For instance, business credits after 20 years, or capital loss carryovers for corporations after 5 years forward. Taxpayers sometimes lose credits simply by forgetting they expire and not utilizing them in time. Businesses should plan to use credits before they lapse.

• ❌ Mistiming the carryback vs carryforward (when applicable): If you ever are in a situation where a carryback is allowed, carefully decide whether to carry back or waive it. Sometimes taxpayers automatically carry forward when a carryback could have given an immediate refund that’s more valuable. Conversely, sometimes carrying back a loss to a year that had a low tax rate might waste it, and carrying forward to a higher tax rate environment could save more. You usually have to elect to waive a carryback within the return or via a timely filed statement.

• ❌ Ignoring Section 382 and other change-of-ownership rules: For companies with NOLs and credits, a merger, acquisition, or major stock issuance can trigger limitations. A mistake companies make is failing to do a Section 382 study after a big ownership change – then they might overuse NOLs beyond the allowed annual limit, which can be disallowed upon IRS exam. Always perform diligence on carryforward assets during M&A; it’s complex tax territory often requiring expert analysis. Similarly, S-corps converting to C-corps or vice versa have unique rules about carryforwards. If going public or being acquired, make sure you don’t assume all your tax attributes can be freely used by the successor.

• ❌ State carryforward mismatches: A big pitfall is assuming your federal carryovers apply to state. If you moved states, your loss carryforward might not move with you. States have varying rules on this.

• ❌ Overlooking carryforwards in the final year of a trust/estate or corporate dissolution: When an entity closes, certain carryforwards might be transferable or usable on the final return. Executors sometimes miss passing out the final-year deductions and loss carryovers to beneficiaries, thereby losing those deductions. Similarly, if a corporation dissolves with unused credits or NOL, generally those disappear unless there’s a merger where a successor can use them. It’s a “use it or lose it” moment.

• ❌ Not filing required forms: While carryforwards mostly happen automatically, some situations require a form or disclosure. For instance, if you elect to forgo a carryback of an NOL, you needed to attach that election. Or partnerships with 163(j) must file Form 8990 if they have carryforward info to report. Neglecting these forms can lead to penalties or at least confusion. Always read IRS instructions when you have a carryforward.

In short, stay organized and informed. Use a checklist at tax time: “Do I have any carryovers from last year? Am I properly accounting for current year limits? Did anything happen that affects their use?” By avoiding the above mistakes, you ensure you get the full benefit of your hard-earned (or hard-lost!) tax attributes and remain in the IRS’s good graces.

Evidence and Expert Insights 🔍

The rules on carryforwards are grounded in tax code and IRS guidance. Here we compile a few authoritative references and insights that reinforce the points covered:

• The IRS explicitly disallows carrying forward income. The tax code does not contain any provision to defer taxable income to future years (outside of specific deferral vehicles or installment sale rules). Instead, it provides relief only for losses. As noted by the IRS, “If your deductions for the year are more than your income for the year, you may have a net operating loss (NOL)… You can use an NOL by deducting it from your income in another year” This implies the converse: if income exceeds deductions, there’s no analogous provision to push it out to another year – you simply have taxable income.

• IRS guidance on net operating losses highlights that after 2020, NOLs generally can only be carried to later years (no carryback), and that any excess business loss of an individual is converted into an NOL carryover, demonstrating Congress’s intent: you must move losses forward, and large losses are curtailed and systematically carried over via NOL treatment.

• The Tax Cuts and Jobs Act (TCJA) of 2017 changed long-standing rules: it removed the 2-year NOL carryback and 20-year limit in exchange for indefinite carryforward with an 80% cap. This legislative history suggests a policy choice: allow full loss utilization but spread it out so companies always pay some tax if profitable.

• The definition of “Excess Taxable Income” (ETI) for partnerships under Section 163(j) is that it is the amount of adjusted taxable income of the partnership in excess of what it needed to deduct its business interest expense. This supports the description provided on how partnership interest carryforwards get unlocked by future income.

• Judicial precedents have underscored that deductions and credits are a matter of legislative grace. Cases have consistently upheld that carryforwards are tightly regulated and not to be expanded beyond statute.

• Real-world data confirm carryforwards are not just theoretical – they significantly affect tax outcomes. Numerous large corporations have paid no federal tax in profitable years largely thanks to prior-year losses and credits, confirming that these provisions are impactful and carefully monitored.

• Professional advice stresses the importance of tracking carryforwards. Tax experts emphasize, “Forgetting your tax-loss carryforward dollars” is a frequent mistake – you must include the carryforward on the next year’s return or you lose the benefit.