Preliminary Work and Taxpayer Data · Preliminary work to prepare tax returns
Use of prior years' returns for comparison, accuracy and carryovers
tax year · reviewed 2026-08-19 · I. Ohu
The rule
The prior year’s return is the single most useful document in a new engagement, and it does three distinct jobs. It carries balances forward that no current-year document reports. It supplies a comparison that catches what is missing this year. And it establishes the history — methods, elections and positions — that the current return must either follow or consciously depart from.
A preparer may rely on it, subject to one requirement that is easy to skip. Reg. § 1.6694-1(e)(2) permits a preparer to rely in good faith without verification upon a return previously prepared by the taxpayer or another preparer and filed with the IRS — the regulation’s own example being that a preparer of an amended return need not verify the positions on the original. Three qualifications follow. The preparer may not ignore the implications of information furnished or actually known; must make reasonable inquiries if the information as furnished appears incorrect or incomplete; and must confirm that the position being relied upon has not been adjusted by examination or otherwise. That last requirement has no counterpart in the general reliance rule, and it is satisfied by a transcript rather than by the client’s file copy.
Reg. § 1.6694-2(e)(4) makes the same point from the penalty side: a review of the prior year’s return is one of the elements of the normal office practice that the reasonable cause and good faith exception rewards.
Current figures
| Carryover | Period and limit |
|---|---|
| Net operating loss | a net operating loss arising in a taxable year beginning after 31 December 2017 carries forward to each taxable year following the loss, with no expiry and — outside the farming and insurance exceptions — no carryback (IRC § 172(b)(1)(A)(ii)(II))TY2026 |
| Net operating loss — annual limit | the deduction for post-2017 losses is capped at 80 percent of taxable income computed without the § 172, § 199A and § 250 deductions, while pre-2018 losses are deductible in full and are taken first (IRC § 172(a)(2))TY2026 |
| Capital loss — annual deduction against ordinary income | $3,000, or $1,500 for a married individual filing a separate returnTY2026 |
| Capital loss — carryforward | indefinite, with the short-term and long-term components carried forward separately and retaining their characterTY2026 |
| Excess charitable contributions | the 5 succeeding taxable years, in order of time, subject in each year to the same percentage limitationTY2026 |
| Disallowed passive activity loss or credit | indefinite — a loss or credit disallowed under IRC § 469(a) is treated as allocable to the same activity in the next taxable year, and is released on a fully taxable disposition of the entire interest (IRC § 469(b), (g))TY2026 |
| Prior year minimum tax credit | the adjusted net minimum tax imposed for all prior taxable years beginning after 1986, less amounts already allowed as a creditTY2026 |
How it works in practice
Inventory the carryovers first. They are the items a new preparer will otherwise simply lose, because nothing arriving in January reports them. Capital losses carry forward indefinitely, and the short-term and long-term components carry separately and keep their character — a distinction that changes the current-year netting and is destroyed by lumping them together. Charitable contributions in excess of the percentage limit carry to the five succeeding years in order of time, so the oldest is used first and an unused fifth-year amount simply expires. Passive losses carry to the next year as a deduction allocable to the same activity (IRC § 469(b)), which means the carryforward has to be tracked activity by activity rather than in a single pool. A minimum tax credit under § 53 can sit unused for many years and is invisible without the prior return.
The net operating loss rules changed shape and the vintage matters. A loss arising in a taxable year beginning after 2017 carries forward indefinitely but is subject to the eighty per cent limitation in § 172(a)(2); a loss arising before 2018 has a twenty-year life and no such limitation. Where a client has both, § 172(a)(2) absorbs the older, pre-2018 losses first and in full, and applies the eighty per cent ceiling only to the post-2017 layer. A schedule that tracks the two vintages separately is not optional bookkeeping; it is the only way to compute the deduction.
Compare, line by line, and ask about the gaps. The comparison is where omissions surface. An interest or dividend payer that appeared last year and not this year is either a closed account, a sold holding, or a missing document — and the client knows which. A Schedule C with materially different revenue, a disappeared state tax refund, a rental that stopped reporting depreciation, a dependent who is no longer listed: each is a question, and each takes seconds to ask at intake and much longer to resolve after filing.
Elections and methods bind. Accounting method, depreciation conventions and lives, an election to capitalise carrying charges, a mark-to-market election, the treatment of installment sales — these were set in an earlier year and continue. Reversing one silently is a method change, not a fresh choice, and the prior return is where the practitioner learns which choices are already made.
Basis and depreciation live in the prior return. Accumulated depreciation, the remaining basis of every asset, the split between land and improvements, and any § 179 or bonus election are carried forward on the depreciation schedule and nowhere else. Losing that schedule is how a client ends up reconstructing basis from closing documents a decade later.
The carryover that had been adjusted
A new client brings four years of returns showing a substantial net operating loss carryover. The preparer takes the closing balance from the most recent return and carries it forward.
The account transcripts show that one of those years was examined and the loss reduced by nearly half. Reg. § 1.6694-1(e)(2) permits good faith reliance on a previously filed return, but expressly requires the preparer to confirm that the position relied upon has not been adjusted by examination or otherwise. That confirmation is an affirmative step, not an assumption, and the client’s own copy of the return cannot supply it — only the account transcript shows what happened after filing. Ordering transcripts at the start of every new engagement is what makes this automatic rather than a matter of remembering.
Two vintages of loss
Beatrix Sørensen-Adeyemi has a net operating loss carryforward built from a 2016 loss and a 2021 loss. Her preparer combines them into one figure and applies the eighty per cent limitation to the whole.
That understates her deduction. Section 172(a)(2) allows the aggregate amount of losses arising before 2018 in full, and applies the eighty per cent ceiling only to the post-2017 layer, measured against taxable income computed without the NOL deduction and the § 199A and § 250 deductions. The 2016 loss is used first and without limitation; only the 2021 loss meets the ceiling. The consequence of merging them is a smaller current deduction and a carryforward schedule that will stay wrong for as long as it survives.
The dividend that stopped
Comparing to the prior return, a preparer notices that a payer reporting several thousand dollars of dividends last year appears nowhere this year. The client says nothing was sold.
The comparison has found a missing information return, which is the outcome this step exists to produce. The account was moved to a different custodian mid-year and the year-end statement went to an old address. Without the comparison the return would have been filed short by several thousand dollars, and the correction would have arrived as an underreporting notice with an accuracy-related penalty attached. A single question at intake, prompted by a line that changed, prevented all of it.
How this has changed
The Tax Cuts and Jobs Act rewrote net operating losses in 2017, replacing a two-year carryback and twenty-year carryforward with, for losses arising after 2017, no carryback for most taxpayers, an indefinite carryforward, and the eighty per cent limitation. The CARES Act then suspended that limitation and restored a five-year carryback for losses arising in 2018, 2019 and 2020, before the limitation returned for taxable years beginning after 2020. The practical residue is that a client’s carryforward schedule may contain up to three layers with different rules, and the vintages must be tracked separately — the arithmetic is not recoverable from a single combined figure.
The reliance rule itself arrived with the 2008 preparer penalty regulations, which for the first time stated in terms that a preparer may rely on a previously filed return and attached the three qualifications, including the requirement to confirm that a relied-upon position has not been adjusted. Transcript access through e-Services has since made that requirement a matter of ordinary diligence rather than an aspiration.
Everything else here is durable. Capital loss carryovers, the five-year charitable carryover, the per-activity passive carryforward and the minimum tax credit have all worked the same way for decades, and they are lost in practice through inattention rather than through changes in the law.
Exam focus
Know which carryovers exist and their periods: capital losses indefinitely with character preserved and the annual offset against ordinary income in the figures table; charitable contributions five years in order of time; net operating losses indefinitely for post-2017 vintages, subject to the eighty per cent limitation; passive losses to the next year allocable to the same activity; and the minimum tax credit under § 53. Know that a preparer may rely in good faith on a previously filed return but must confirm the position has not been adjusted, and that a review of the prior year’s return is an element of a normal office practice.
Check yourself
1. A preparer relies on a carryover figure taken from a previously filed return. What must be confirmed?
A. That the client’s copy matches the original as filed B. That the position relied upon has not been adjusted by examination or otherwise C. That the earlier preparer held a valid PTIN D. Nothing; reliance on a filed return is unqualified
Answer: B.
2. How long may an individual carry forward an unused excess charitable contribution?
A. Indefinitely B. Three succeeding years C. Five succeeding years, in order of time D. Twenty succeeding years
Answer: C. An amount not used by the fifth succeeding year expires.
3. What happens to the character of a capital loss carried forward?
A. All carryovers become short-term B. All carryovers become long-term C. Short-term and long-term components carry forward separately and retain their character D. Character is redetermined each year by the taxpayer
Answer: C.
4. A taxpayer has net operating losses from 2016 and from 2021. How is the deduction computed?
A. The combined amount, limited to 80 percent of taxable income B. The 2016 loss in full first, with the 80 percent limitation applied only to the 2021 layer C. The 2021 loss first, because later losses take priority D. Each layer limited to 80 percent separately
Answer: B. Pre-2018 losses are allowed in full and are absorbed first.
5. A disallowed passive activity loss is carried forward. How is it treated?
A. As a deduction against any income in the next year B. As a capital loss in the next year C. As a deduction or credit allocable to the same activity in the next taxable year D. It expires after five years
Answer: C — which is why suspended losses must be tracked activity by activity.
Change log
- Initial draft.
Related topics
- Filing requirements and due date 1.1.1.d
- Taxpayer filing status (e.g., single, head of household) 1.1.1.e
- Items that will affect future/past returns (e.g., carryovers, net operating loss, Schedule D, Form 8801, negative QBI carryover) 1.5.1.g
- Previous IRS correspondence with taxpayer 1.1.1.l
- Sources of all worldwide taxable and nontaxable income (e.g., interest, wages, business, sales of property, dividends, rental income, flow- through entities, alimony received) 1.1.1.f
- Sources of tax payments and refundable credits (e.g., withholding, estimated payments, earned income tax credit) 1.1.1.k
- Conditions for filing a claim for refund (amended returns) 1.5.1.n
- Penalty of perjury 1.5.1.o