Tax Tip for the Self Employed: The Strategic Use of Tax Losses

Self Employed Tax Losses

Making a loss in business is perfectly normal however if you are self employed it can be worrying. Will anyone see it? What will HMRC say? What happens next? These are all questions you may be asking yourself.  Today I answer these questions, dispel some myths and show how with a strategic use of your tax loss you can really make them work in your favour.

What is a Tax Loss

A tax loss occurs when your taxable expenses exceeds your taxable incomes. The loss on your tax return may not match the loss in your business accounts because HMRC sets out what it calls allowable and disallowable expenses. These are expenses that you can get tax relief on and those that you can’t, for example entertainment is a disallowable expenses whereas accounting fees are fully allowable.  In addition to these types of expenses, there are allowances that you can claim for to help reduce your tax bill such as the Annual Investment Allowance, which may contribute to your tax loss but are not reflected in your business accounts.

Who Knows About Your Tax Loss

Your tax return is confidential to you, anyone you authorise to deal with your tax affairs, like an accountant and of course HMRC.  So without your permission no one else will know you have made a tax loss.

What Will HMRC Say

When you are self employed and dealing with your own taxes, you are always open to the possibility of an investigation by HMRC.  In this event HMRC will ask to see documentation to support the figures in your tax return, so make sure you keep all necessary business records to support your figures and be able to demonstrate how you reached your tax loss.

Strategic Use of Your Tax Loss

1. Carry Back Your Tax Loss

If you have been self employed for a while you can choose to carry back your tax loss one year and set it against any profits you made in your business, possibly generating a tax repayment.  You need to:

  • Claim this on your tax return in the self employment section;
  • Start with the most recent tax year and work your way back;
  • Not be preparing your return under a cash basis.

If you are newly self employed then tax losses made in the first four years of trading can be carried back to the previous 3 years.

2. If You Are Employed Your May Be Able to Get a Tax Refund

If you are employed and self employed and your business made a loss, then depending on your earnings you may be able to generate a tax refund of the tax you paid in your employment with your business loss.  If you are newly self employed then tax losses made in the first four years of trading can be carried back 3 years and used against income or earlier profits your business made (just make sure you are not using the cash basis for preparing your return).  When you submit your tax return there is an option to set your self employment loss against other income.

Example – Lucy

Lucy was employed for the tax year 2017/2018 and her P60 should gross earnings of £30,000, she was also starting a side business and made a tax loss of £4,000 in the same tax year.  By completing a tax return Lucy can elect to set her business tax loss of £4,000 against her gross earnings generating a tax repayment of the tax she has paid in her job.

Example – Emily

Emily was also employed and earned a gross salary £10,000 in 2017/2018, so paid no tax on these earnings.  Emily also started a small side business and made a tax loss of £1,000 in the same tax year.  Since Emily’s employment earnings are below her personal allowance, relieving the business loss against her employment earnings will not generate any refund so there is no point doing a set off.  Emily will need to consider other strategic ways of using her tax loss (such as setting it against any capital gains or carrying her tax loss forward, see below).

Tax Tip – if you loss is more than your other income, only elect to set off the same amount of your other income and then work out the best use of the remaining amount of your tax loss, so you don’t loose the benefit all at once

3. Set Your Tax Loss Against Capital Gains

If you have made a capital gain in the same tax year that you made a tax loss you can choose to set your Tax Loss against this gain.  Watch out, if you have employment income you’ll need to set your tax loss against this FIRST, then use any of the remaining loss against your capital gain.

Again, you can claim to carry back a tax loss on your tax return and only if you are not using cash basis for your accounts.

For both points 2 & 3 above you can also elect to carry back your tax loss for up to 3 previous tax years and use it against gross income from employment and capital gains – you’ll need to start with the previous year and work your way back in time though.

4. Carry Forward Your Tax Loss

You can choose to carry forward some or all of your tax loss and use it against future profits you make in your business (not any other income though), reducing your tax bill in the coming years.  Make sure you keep a note of the tax losses you carry forward so you know exactly what you have available for use.  This will happen automatically on your tax return, unless you elect to do something else with your tax loss.

You must remember that you do need to fill out a tax return to log a Tax Loss. Whether you want to set your tax loss off now or in the future and how you use it is entirely up to you (you could use a combination of the above if it suits you).  Always consult a professional to help you calculate your tax loss or advice on how best to strategically use your tax loss.

Tax Tip for the Self Employed: Tax Losses & Class 4 National Insurance