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This article was fact-checked by our editors and reviewed by Christina Taylor, MBA, senior manager of tax operations for Credit Karma Tax®.
Are tax deductions and credits always “use it or lose it”?
The tax code contains multiple deductions and credits that eligible taxpayers can use to reduce their tax liability and even generate a refund. But what if you can’t take full advantage of a deduction or credit in a given year? Do you miss out on that tax break altogether?
Well, that depends.
In some cases, you still may be able to take a deduction or credit as a “carryforward,” but there are rules for how and when you can do so. Let’s look at what a tax carryforward is and how it could work for you.
What is a tax carryforward?
You may be eligible for a certain tax deduction or credit in a given tax year but can’t take full advantage of the tax break. This can happen for three basic reasons.
- Your total expense for a permitted deduction exceeds the amount you’re allowed to deduct for that expense in a given year
- A credit you qualify for exceeds the amount of tax you owe in a year, and the credit is a nonrefundable one
- You have a net operating loss, or NOL, because your losses are more than your taxable income in a given year
When one of these scenarios occurs, you may be able to take a carryforward (or carryover), applying some or all of the unused portion of the credit or deduction, or claiming a net-operating-loss deduction, in a subsequent tax year. How long the tax carryforward remains available and what you have to do to claim it varies depending on multiple factors.What's the difference between a tax credit and a tax deduction?
Carrying forward losses
Ideally, every year your income should exceed your expenses. However, things can happen in life that end up leaving you with a negative balance sheet at the end of the year. If you experience a loss, you may be able to carry over a deduction for your loss into future tax years.
When your deductions for a tax year are more than your income for the same year, you might have an NOL. Any NOL you may have could potentially be carried over as a deduction from your income in previous tax years. You do this by filing an amended tax return, in which case you might get a refund for those years. Or you may choose to carry forward your loss and deduct it from future tax years, which could reduce your taxable income for those years.
The IRS requires taxpayers to make certain adjustments to their taxable income to determine how much NOL will be applied to the current tax year and how much will carry forward, and you must include a statement with how you calculated this deduction. Under tax reform, businesses can now carry forward net operating losses indefinitely but are limited to deducting no more than 80% of taxable income for losses arising after December 31, 2017.
You may also be able to carry forward capital losses. A capital loss can occur when you sell an asset (like your home, car, investment property, stocks, bonds, etc.) for less than what you paid for it.
Patrick Colabella, a CPA and assistant professor of accountancy at St. John’s University’s Peter J. Tobin College of Business, says capital losses can’t be applied against other types of income, only capital gains. If your capital losses exceed your capital gains by more than $3,000 , then the excess must be carried over, and a taxpayer has until his or her death to apply the carryforward.
Carrying forward charitable contributions
Giving to charity is a way to do some good while getting a tax break. However, there are limits on how much of a deduction you can take for your charitable contributions. Generally, you can deduct donations to qualified charities of up to 60% of your adjusted gross income, although that percentage can vary depending on income limits, the type of property you donate, and the kind of organization you give it to.
If your charitable donations equal more than the amount you’re allowed to deduct in a given tax year, you may be able to carry excess contributions forward to a future tax year. For most types of contributions, you’re allowed to carry forward the deduction for up to five years. However, for qualified conservation contributions (for example, if you donate a piece of land to a qualified organization for conservation purposes) the carryforward limitation is 15 years.
Credits you can carry forward
Of course, deductions aren’t the only way to reduce your tax burden. While tax deductions reduce the amount of income you pay taxes on, tax credits are dollar-for-dollar reductions in the amount of tax you owe. Some tax credits can also be carried forward.
Adoption tax credit
When you adopt a child, you may be able to claim a credit for some of the costs associated with adoption, provided you meet qualifications such as the type of expense and income limits. For 2017, the credit begins to phase out for people whose modified adjusted gross income is $203,540. If your MAGI is $243,540 or more, you couldn’t claim the credit at all for 2017.
The adoption credit is nonrefundable, meaning if the credit reduces your tax liability to zero you can’t get a refund for any remaining credit. However, if the credit exceeds your tax liability, you can carry the remaining amount forward for up to five years.
Foreign tax credit
The foreign tax credit allows eligible U.S. citizens and resident aliens who live abroad to reduce the amount of taxes they pay so as not to double up on paying taxes to both the U.S. and their host country on the same income. If you can’t claim a credit for the full amount of foreign taxes you paid or accumulated in a given tax year, you can carry forward the amount of unused foreign income tax credit for up to 10 years and apply it to a future tax return.
Credits for energy efficiency
The government also awards a tax credit to taxpayers who purchase energy-efficient equipment to reduce their energy consumption. The Residential Energy Efficient Property Credit equals up to 30% of the costs of purchased equipment (like solar water heaters and solar electric equipment), while the Non-Business Energy Property Credit is 10% of the costs of qualified items, which can include energy-efficient windows, doors and roofs. With the Residential Energy Efficient Property Credit, taxpayers can carry forward the unused portion of the credit from the current year’s tax return to the next year’s tax return. For the Non-Business Energy Property Credit, the carryforward period is 20 years.
Along with IRS rules for when certain deductions or credits can be applied to subsequent tax years, Colabella says that using a carryforward should depend on “whether or not the taxpayer achieves a better tax result.”
Carryforwards can help to reduce a taxpayer’s tax liability, but carryforward losses, credits and deductions are extremely complex, Colabella says, and the various IRS rules don’t make it any easier for the average taxpayer to figure these things out on their own.
“I highly recommend that any taxpayer consult with a CPA for a thorough explanation of the taxpayer’s position with respect to these items,” Colabella says.
That means that rather than risk costly errors when you file with the IRS, you would probably be better off consulting a professional and getting specific tax advice before you use these maneuvers on your current or future tax returns. When you’re ready to file, you don’t necessarily have to pay a professional to file for you. You may be able to carry forward deductions and credits and still use a free online tax-filing service like Credit Karma Tax®.
Christina Taylor is senior manager of tax operations for Credit Karma Tax®. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.