Using Credit and Loss Carryforwards to Smooth Tax Liability

How credit and loss carryforwards work — a practical overview

Credit and loss carryforwards are two related but distinct tools in the U.S. tax code. A loss carryforward most often refers to a net operating loss (NOL) that can be applied against taxable income in later years. A credit carryforward refers to unused portions of nonrefundable tax credits that the taxpayer is permitted to apply to taxes in future years. Used together, they help taxpayers manage year-to-year volatility in taxable income and preserve the after-tax value of deductions and credits that aren’t fully usable in the year they arise.

In my practice advising small businesses and owner-operators, I frequently see carryforwards rescue cash flow and reduce tax surprises: losses from a startup phase become future shields against profit, and unclaimed credits from an energy project can reduce taxes once revenue stabilizes.

Sources and rules

• The IRS explains NOL rules, carryforward mechanics, and filing requirements on IRS.gov. For business and individual NOL guidance, see the IRS NOL resources (IRS). For rules on credits and their carryforward periods, see the IRS pages on general business credits and specific credit guidance (IRS).
• Our site has deeper articles on NOLs and related processes: see our coverage of Net Operating Loss (NOL) Carrybacks and Carryforwards and the Excess Business Loss Limitation for context and examples.

Internal links:

• net operating loss (NOL) carrybacks and carryforwards: https://finhelp.io/glossary/net-operating-loss-nol-carrybacks-and-carryforwards/
• Excess Business Loss Limitation: https://finhelp.io/glossary/excess-business-loss-limitation/
• Amending a Return for Net Operating Loss Carrybacks and Carryforwards: https://finhelp.io/glossary/amending-a-return-for-net-operating-loss-carrybacks-and-carryforwards/

Key differences between credits and losses

• Effect on tax: Credits reduce tax dollar-for-dollar; losses reduce taxable income and therefore reduce tax indirectly. A $1,000 credit lowers tax owed by $1,000; a $1,000 loss lowers taxable income, which reduces tax by your marginal tax rate times $1,000.
• Refundability and timing: Refundable credits can produce refunds immediately. Nonrefundable credits reduce tax to zero and any unused portion may be carried forward under statutory rules. NOLs are carried forward (and, in limited cases, carried back) to reduce taxable income in future years.

Common statutory points as of 2025 (what to watch for)

• Carryback vs. carryforward: After TCJA (2017), most NOLs arising in tax years beginning after 2017 could not be carried back and instead were carried forward indefinitely. The CARES Act (2020) temporarily allowed carrybacks for certain years, and later legislative changes restored the general rule that most NOLs must be carried forward. Always check the tax year of the NOL to know the applicable rules (IRS).
• Limitation on NOL deductions: For NOLs arising in tax years beginning after 2020, the deduction is generally limited to 80% of taxable income (computed without the NOL) — an important planning constraint. The 80% limit was suspended temporarily for certain years by the CARES Act but returned thereafter; confirm treatment for each NOL year.
• Excess business loss rules: Noncorporate taxpayers are subject to the IRC 461(l) excess business loss limitation. If your business losses exceed the statutory threshold for a year, the excess is disallowed and becomes an NOL carryforward. These limits are indexed and have specific rules; for details see our Excess Business Loss Limitation article and consult IRS guidance.

How credits are carried forward: patterns and examples

• General business credits (IRC Sec. 39) commonly carry forward up to 20 years, but the carryforward period varies by credit. For example, certain energy or rehabilitation credits have their own time limits and interaction rules.
• Individual credits such as the adoption credit historically allow a limited carryforward (for example, five years) when fully nonrefundable; other individual credits are refundable and do not need carryforward treatment.
• The Inflation Reduction Act and subsequent legislation have changed or expanded several credits (notably energy and climate-related credits). Many new or enhanced credits are nonrefundable and therefore inherently rely on carryforwards when your tax liability in the credit year is insufficient to use the full value.

Examples that illustrate the mechanics

Example 1 — NOL carryforward for a small business owner

• Year 1: Startup incurs $60,000 net operating loss.
• Years 2–4: Profits: Year 2 = $20,000; Year 3 = $90,000; Year 4 = $50,000.
• The business applies the NOL carryforward against Year 3 income when profitability returns, reducing taxable income in that year and smoothing tax payments as revenue recovers.

Example 2 — Credit carryforward

• Year 1: Taxpayer earns a $7,000 nonrefundable energy credit but has only $4,000 in tax liability. The unused $3,000 carries forward to future years subject to statutory carryforward length for that credit. In Year 2, the taxpayer can apply the $3,000 against tax owed.

Coordinating NOLs and credits

When both an NOL and credit carryforwards are available, the order of operations matters: NOLs reduce taxable income, which can change your tax before credits are applied; credits reduce tax liability after income and deductions are computed. In practice:

1. Compute taxable income (apply NOLs according to the rules for that NOL year). Remember the 80% limitation applicable to many post-2020 NOLs.
2. Calculate tax on taxable income.
3. Apply nonrefundable credits up to the tax liability; carry any unused portion as allowed by the credit’s statute.

Careful sequencing can maximize benefit. For instance, in a year when an NOL only partially reduces taxable income, applying credits after using as much NOL as allowed can still leave unused credits to carry forward — a planning lever you can adjust with timing of income recognition or elective carryback (where permitted).

Filing, documentation, and tracking carryforwards

• Track years and amounts carefully: NOLs often have a tax-year-of-origin that dictates the rules that apply. Keep worksheets that show how each year’s loss or unused credit was computed and carried.
• Forms: NOLs and related adjustments can show on Form 1040 Schedule 1 (for individuals) and on the business returns (e.g., Form 1120, 1065, Schedule K-1 entries) as applicable. Amending returns to use carrybacks (when permitted) may use Form 1139 for corporations or Form 1045 (where allowed) for certain estates and trusts; see IRS guidance and our article about amending returns for NOLs.
• Audit posture: The IRS will expect substantiation for losses and credit claims. Keep contemporaneous records, contracts, receipts, and clear calculations. Documentation is the single biggest factor that helps these positions survive an audit.

Practical strategies and tips

• End-of-year planning: If you can control timing of income or deductible expenses (common for small business owners), project taxable income and consider whether accelerating or deferring items can preserve or multiply the value of carryforwards.
• Evaluate electing carrybacks where allowed: Some statutes or temporary reliefs permit carrybacks. Carryback refunds accelerate cash recovery but may reduce future offset options—model both scenarios.
• Use software and a carryforward schedule: Maintain a simple Excel worksheet or tax software record that lists year-of-origin, amount available, how much used, and remaining balance for each carryforward.
• Coordinate with advisors: Complex interactions (multi-state taxes, AMT considerations, partnership passthroughs) can change results — run scenarios with a CPA or tax advisor.

Common mistakes to avoid

• Not tracking the year-of-origin: Rules can differ depending on the tax year in which the loss or credit originated.
• Confusing refundable and nonrefundable credits: Refundable credits do not need to be carried forward. Treat nonrefundable credits with their statutory carryforward rules.
• Overlooking limitations: The 80% NOL limitation and excess business loss rules can significantly change the usable amount in a year.

Frequently asked questions (brief)

• Can I carry forward a loss indefinitely? Many NOLs arising after TCJA are carried forward indefinitely, but the usable deduction each year may be limited to 80% of taxable income. Check the year the NOL arose for the exact rules.
• How long can I carry forward credits? Carryforward periods vary by credit; some general business credits carry forward up to 20 years, others have shorter windows. Review the credit’s statute and IRS guidance.
• What if I have both NOLs and carryforward credits? Apply NOLs to determine taxable income, compute tax, then apply credits. Coordinate sequencing for best tax outcome.

When to get professional help

If you have significant carryforwards, multi-year losses, or complex credits (R&D, energy, low-income housing), consult a CPA or tax attorney. In my experience, a short planning session to model carryforward use often uncovers opportunities that more than pay for advisory fees.

Authoritative sources and further reading

• IRS — Net Operating Losses (NOLs): https://www.irs.gov
• IRS — General Business Credit and individual credit pages: https://www.irs.gov
• FinHelp.io articles: Net Operating Loss (NOL) Carrybacks and Carryforwards; Excess Business Loss Limitation; Amending a Return for Net Operating Loss Carrybacks and Carryforwards.

Professional disclaimer

This article is educational and does not replace individualized tax advice. Tax law changes frequently; confirm current rules with the IRS or a qualified tax professional before making decisions. In my practice, I rely on up-to-date IRS guidance and client-specific modeling to recommend optimal carryforward strategies.