In Finance, what is a Reachback?

Malcolm Tatum

The reachback is an accounting strategy that is sometimes used to claim tax deductions at the end of the calendar or business year that relate to expenses incurred earlier in the year. This approach is sometimes employed by companies that are established as limited partnerships, as well as part of a tax shelter strategy. While still allowed in many areas, this type of strategy is no longer considered permissible in several nations around the world. When still an option, the reachback is often limited to use in specified situations.

The reachback accounting strategy is sometimes used by companies that are established as limited partnerships.
The reachback accounting strategy is sometimes used by companies that are established as limited partnerships.

In practice, a reachback strategy makes it possible to delay claiming certain deductions in one quarter, with the anticipation of applying them in a different quarter. For example, a business may choose to wait until the fourth quarter to claim deductions related to expenses that were incurred during the first quarter. This is accomplished by reaching back to those earlier unclaimed deductions, and applying them to the income and expenses that were generated during that fourth quarter. Depending on the financial circumstances that prevailed during that last quarter of the year, conducting a reachback could result in a significant reduction of the tax burden.

While there are countries where using a reachback is still considered legal, it is not unusual for tax agencies in those nations to impose limitations on the type and the amount of those expenses that can be incurred in one part of the year and applied in a different part. The idea behind these limitations is that companies where seasonality impacts the overall operating structure of the company can still have the benefit of using the tax deductions where they are most helpful, and thus aid the business in remaining operational throughout the calendar year. At the same time, the limitations help minimize the possibility of abuse by businesses that do not experience seasonal fluctuation in their revenue streams and find it easier to operate at the same level of production all year long.

Abuse is often the reason cited for limiting or completely outlawing the reachback as a legitimate accounting practice. Depending on how tax laws are written, this type of strategy may function as a broad loophole that makes it easy to reduce the tax burden under a wide range of situations. For this reason, more agencies during the latter part of the 20th century began to look closely at how businesses of various sizes were making use of the reachback, and started to implement changes to tax regulations that effectively eliminated some of those applications. Proponents of these limitations support the idea that doing so can prevent businesses from obtaining an unfair advantage when it comes to paying taxes. Opponents to reachback limitations sometimes see the attempts to moderate the use of this strategy as being counter-productive to encouraging the growth of businesses.

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