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Carryovers of Unused Tax Breaks: Use ‘Em or Lose ‘Em
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Carryovers of Unused Tax Breaks: Use ‘Em or Lose ‘Em
New taxpayers, such as recent graduates who’ve just entered the job market, probably have a clean tax slate. But seasoned taxpayers have a history that can impact their taxes going forward. Due to limitations and restrictions, some tax breaks cannot be fully used in the year in which they are generated but can be carried over and used in other years. Failing to know what these are and keep track of them wastes valuable tax breaks that can cost you money.
Tax breaks subject to carryovers
Dollar limits and other restrictions curtail write-offs for your current and past outlays. Here are some to note:
Capital losses. If you sell property but your long-term capital losses exceed your capital gains, you can use the excess to offset up to $3,000 of ordinary income (e.g., wages; interest income). Any excess can be carried forward indefinitely to offset capital gains and $3,000 of ordinary income in future years.
Charitable contributions. Most people aren’t generous enough to worry about any limitations on their annual contributions, but some may be. For individuals, the annual limit is based on a percentage of adjusted gross income; for C corporations, the limit is 10% of taxable limit. These carryovers usually have a five-year limit, but a longer one applies for donations of conservation easements.
General business credit. Business credits, such as the small employer health insurance credit and the research credit (if extended for 2014), are subject to an overall annual dollar limit keyed to income. Total credits exceeding this limit can be carried back one year and forward for up to 20 years.
Home office deduction. If you figure it based on actual expenses and they exceed gross income derived from your home office activity, the excess is carried forward. There’s no time limit for the carryover and you don’t even have to be in the same home office when you use it. All you need is gross income from your home office activity. Note: If you figure your deduction using the simplified method, it too is limited to gross income, but there’s no carryover allowed.
Investment interest. Interest on loans to buy investments, including stock in your closely-held C corporation, is deductible as an itemized deduction only to the extent of investment income each year. Similarly, an investment interest expense of an S corporation, partnership, and limited liability company passed through to owners is treated as investment interest on the owners’ personal tax returns.
Net operating losses. If your business had a bad year, you may be eligible for a net operating loss (NOL). This is not a separate deduction; it’s computation of your loss (with certain adjustments) that can usually be carried back for 2 years and forward for up to 20 years; the carryback can be waived so NOLs are only carried forward. The NOL offsets income in the carryback/carryover years to reduce taxes in those years.
Passive activity losses. If you are an investor in a business but don’t materially participate, your losses are limited annually to income from this and other passive activities (including rental realty). Losses can be carried forward indefinitely and used to the extent of passive activity income each year. If you dispose of your interest in a taxable disposition (e.g., you sell your interest to an unrelated party), any remaining losses from this activity can be used in the year of the disposition without regard to passive activity income.
This list is not exclusive. There are carryovers for any unused foreign tax credit, residential renewable energy credit (for solar panels, etc.), and the minimum tax credit.
Recordkeeping of carryovers
The good news about recordkeeping is that you may not need to keep any yourself; your computer or your tax return preparer may do it for you. If you self-prepare returns and use the same software or cloud option, it keeps track of carryovers for you. Then, when you import last year’s information for this year’s return, the information is automatically there. Similarly, if you use a CPA or other paid preparer, the preparer’s software will track the information.
However, if you change preparers, it may not be easy for your new professional to reconstruct carryovers. You’ll need to provide old tax returns and supporting documents.
Even if you don’t need to keep track of carryovers, it’s helpful to do so as a reminder of tax breaks you’ll be able to claim. This may reduce your estimated taxes for the current year and help your cash flow.
Pay attention to tax breaks that aren’t fully utilized currently so you can benefit from them in the future. The onus is on you!
About the Author:
Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BarbaraWeltman.