Being self-employed or being a partner in a partnership can be rewarding, but it can also come with various challenges. Although your business may make a good profit in the tax year, you might also have paid out a large sum for new equipment or other business expenditure. This could result in a trading loss or an Income Tax loss.

It's important that you calculate your losses in the same way that you calculate your profits in each tax year. The results from the calculations could impact how much tax you pay and your company's overall turnover.

There are various options when it comes to claiming tax relief on trading losses incurred, which can help to reduce your tax bill or may even result in a tax refund.

In this guide, we'll look at what Income Tax losses are, how they are calculated and what they mean for your accounts in each financial year. We'll also look at how you should report the losses and your options when it comes to tax relief and trading allowances.

Income Tax is a tax that you pay on your eligible income. This includes profits that you have made from your company if you are self-employed or in a partnership or income that you have earnt from investments and interest on savings. You may find that you have Income Tax losses from trading, the disposal of a capital asset or a property rental business.

A loss will occur if your capital allowances and allowable business expenses are greater than the income you have gained in the accounting period.

Continue reading to find out how you can calculate Income Tax losses, where you can report the losses and how you can claim a tax refund or carry the losses forward.

An Income Tax loss means that your capital allowance and allowable business expenditure are greater than your income in the accounting period. Income Tax losses can be calculated in the same way that you would work out your profits for the accounting period. You would need to calculate how much profit you have made in the accounting year, along with your expenses and capital allowances.

For example, your income in the accounting period may be £15,000, but your allowable business expenditure is £8,500, and your capital allowance is £9,000. In this instance, you would have an income loss of £2,500.

Even if you didn't claim your capital allowances for the accounting year, you would still make a loss if the business expenditure was larger than your income (although the loss would be smaller). It can sometimes be beneficial to avoid claiming capital allowances until the following accounting year.

Income Tax losses will usually be reported on your Self Assessment tax return. However, you can make a stand-alone claim in certain situations by writing to HMRC with the relevant information. You must ensure that you are within the appropriate time limits when doing so.

Your letter needs to include the name of your trade, how much the loss was, and in which tax period it occurred in. You should also state how you want to use the loss. The letter must also feature your full name, address and Unique Taxpayer Reference (UTR).

If you make a standalone claim before the end of the tax year, you must repeat the claim in your Self Assessment tax return at the end of the year and give details of how much tax was repaid or set off. This information should be written in the section that asks for 'any other information' on the form.

There are several options available to you if you make an Income Tax loss. You can carry back a tax loss, although how you do this will depend on the length of time that you have owned a self-employed business. If you have run your business for over a year, the tax loss can be carried back to the previous accounting year and can be used to reduce the tax liability on the profit that you have made. If you have been self-employed for less than a year, the losses that you make within the first four years reduce your tax liability on the profit that you have made in any of the previous three years.

The situation is more complex if you make a loss in the first or second year of trading but make a profit in the third and fourth years. In this instance, it's a good idea to seek financial advice.

Another option is to claim a tax refund against other income that you have made in the accounting year. For example, you might have income from interest on savings or investments. The loss that you make from your self-employed business can be used to reduce the income tax liability that you have on other income that you have made in the same financial year. The loss can also be used to reduce your tax liability on your income in the previous three years starting from the previous tax year. After this, you will be able to claim a tax refund.

However, you are not liable for Income Tax if your other income in the current tax year or the previous tax years was below the standard Personal Allowance of £12,570. In this situation, you cannot use the self-employment loss.

The third option is to set a tax loss against capital gains. You may make a capital gain by selling something like a vehicle or equipment. You can use your trading loss to reduce the tax liability that you have on the capital gain. However, if you have employment income in the same tax year, you must use the trading loss against that before you use it against a capital gain.

The last option is to carry the Income Tax loss forward to reduce your profits from upcoming financial years, as long as the profits come from the same business. This could be helpful if you predict that you will have a large increase in your future profits for reasons such as lower expenses or new contracts.

If you choose this option, you can only carry forward your loss against future profits made by your business rather than any other source of income such as your salary or interest that has accumulated on your savings. You will have to carry the loss forward if use the cash basis for your accounts.

Operating accounts on a cash basis is a way that small businesses can calculate income and expenses. You only need to declare money when it comes in and out of your business. At the end of the tax year, you will only have to pay Income Tax on the money that you received in the accounting period.

The trading allowance is an exemption with a limit of £1,000 that individuals can claim on trading income or property. While claiming the trading allowance may seem like the obvious option, it may not be entirely beneficial if you have made an Income Tax loss. It could be more helpful to complete a Self Assessment tax return and claim for the losses rather than use the trading allowance if your expenses are greater than your income.

Tax relief means that a trading loss that you have made in the tax year is offset against other taxable income. The result is that your taxable income or capital gains are lower than if the loss had not been set off against it. The Income Tax that you are due to pay is consequently calculated on your taxable income or capital gains once the loss has been deducted.

The maximum tax relief that you can claim is limited to £50,000 or 25% of your adjusted total income (depending on which one is higher).

The following are additional reasons why it could prove more beneficial to claim tax relief instead of the trading allowance:

  • your business expenses are greater than £1,000, which means that your taxable profit will be less if you deduct expenses from your taxable income instead of your trading allowance. This will mean that you pay less tax
  • You have multiple trading businesses or casual income. You would need to ensure that your business expenses are lower than £1,000 or you could pay more tax

You can claim relief on Income Tax losses that were made in the final 12 months that your business traded against profits made in the tax year 2021 to 2022. You can make claims against the trade until 5 April 2026.

You can claim against profits that were made in the three previous tax years. You must notify HMRC that your claim is for terminal loss relief and the amount of loss from each year. you must also tell HMRC about the decrease in tax due for earlier years. You should only make the claim if your business ceases trading in the tax year 2021 to 2022.

You can calculate your terminal loss by looking at your cessation accounts and the loss and any unused overlap profit that was made in the last 12 months. You can consider the loss that was made in 2021 and 2022 and a portion of 2023 to 2023 if your accounts to cessation cover a period that is less than 12 months. The cessation accounts are the last accounts that your company files before it ceases trading. You should treat any profit as a nil loss when you calculate the terminal loss.

Income Tax losses occur when your business has great allowable business expenses and capital allowances than profit. You can calculate whether you have losses and how much they are when you calculate your profit for the tax year. Your Income Tax losses could be the result of trading, the disposal of a capital asset or a property rental business.

You have four options after you have calculated your Income Tax losses. You can either carry the loss back to a previous tax year, claim a tax refund against other income you may have (such as interest on savings), set the loss against any capital gains (such as the sale of a vehicle) or carry forward the tax loss if you suspect that you will make a higher profit in the coming tax year.

It may be more beneficial to claim your trading allowance instead of tax relief. Individuals have a tax relief limit of £1,000 that can be used on trading income or property. This isn't beneficial, however, if your expenses are greater than your income. Tax relief, on the other hand, has a limit of £50,000 or 25% of your adjusted total income, whichever is higher. Tax relief means that your trading loss is offset against other taxable income that you have made in the same tax year.