Navigating the complex rules of the UK tax system can take time and effort, particularly when comprehending allowances, deductions, and losses.
An income tax loss can happen at any point in the operation, whether you’re incurring the initial expenses to set up your company or experiencing financial problems later.
Although a loss is not beneficial for your company, you can use it to lower your income tax liability. In this article, we’ll demonstrate how to use income tax losses for your advantage.
Income tax losses occur when permitted deductions and expenditures exceed taxable income for a specific period. When income tax losses occur, the taxpayer may not owe any income tax for that period due to having negative taxable income.
Example
- Your financial year runs from 1st January to 31st December
- You make £15,000 a year.
- Your allowable company expenditure is £8,500
- Your capital allowances are £9,000
- You have made a tax-deductible loss of £2500.
How to use income tax losses for your advantage?
Carry back a tax loss.
Two different alternatives are available, based on the amount of time you have been running your self-employed company.
If you have been in operations for more than one taxation year, you can carry back your tax loss to the prior tax year and utilize it to decrease the tax liability for any profitable earnings you made in that year.
Example
- You made a profitable income of £9,000 in the previous tax year
- You incurred a loss of £3,000 in the current taxation year
- You can lower your prior year’s tax liability to £6,000
- You can file for a refund of the tax you paid on £3,000
If you are new to self-employment, you can utilise any losses you make in the initial four years of trading to offset your tax liability for any earnings you made in any of the three years before.
If you are new to self-employment and generate a loss in years two and four, with earnings in the other two years, the scenario becomes more complicated, and it is best to get tax advice.
Utilize against other income
In certain situations, income tax losses can be utilised to offset different kinds of income, such as employment or investment. This can result in immediate tax savings by decreasing the overall taxable income for the year.
Additionally, investors can deduct capital losses against taxable capital gains, decreasing their net investment income and resulting tax obligations.
Carry forward a tax loss.
If you avoid using any of the previous alternatives, you can select to carry forward an income tax loss to minimise the earnings from self-employment in future tax years. The future earnings must be from the same company.
This option might be helpful if you anticipate a large increase in income in the future due to new contracts or fewer expenses.
However, you cannot use this option against any other source of income, such as interest from savings or an employment salary, but only against future profits from self-employment.
Choose a tax loss against any capital gains.
If you make a capital gain, for instance, by selling machinery or an automobile, you can use your trading loss to minimize any tax liability on the capital gain.
Example
- You make a trading loss, where allowable expense surpasses income, of £2,000
- You earn a capital gain of £3,000
- You can lower the taxation liability on the capital gain to £1,000
If you have employment earnings in the current tax year, you must first count the loss against that.
Suppose you don’t make a capital gain in your current tax year. In that case, you can utilise the loss to decrease the income tax liability on any capital gains in the three earlier tax years, beginning with the previous tax year. After that, you’re eligible for an income tax refund.
Final thoughts
Although income tax losses might initially appear like a setback, they can present firms and individuals in the UK with significant tax savings potential. By knowing how income tax losses operate and how to best use them with the help of an income tax calculator, taxpayers can reduce their tax obligations and strengthen their overall financial situation.
