The science behind carryover losses

February 20, 2024
minutes to read
Ben Winford
Table of Contents

As a small business owner in Australia, it's essential to know about the concept of carryover losses when it comes to tax time. Carryover losses occur when a business has generated a loss in one financial year, which can be carried forward to offset future taxable income. Using a carryover loss can help reduce the tax a business needs to pay in the coming years. Carryover losses are an intelligent way to minimise tax if you predict a profitable year to come. Purposely incurring a loss has advantages and disadvantages that we'll cover in this blog so you can make the right choice for your business.

Carryover losses are an important tool for small businesses to use during tax time because they allow for the carryover of business losses from one tax year to the next. In simple terms, if your small business has a loss of $50,000, you can offset your income by $50,000 in a future year, reducing the amount of taxes you will owe.

What is a Carryover Loss?

To carry over losses as a business, you need to have a net loss in the current income year, meaning your expenses are greater than your annual income. To claim a loss, you must complete the relevant section of the tax return form and attach supporting documentation of your loss. The ATO will assess the claim, and if approved, the loss will be carried forward to offset future income.

Benefits of Carryover Losses

Carryover losses can be beneficial for small businesses that experience fluctuations in income from year to year, as it allows a business to smooth out fluctuations and avoid large tax bills in profitable years. Additionally, carryover losses can help small businesses to maintain financial stability by providing a buffer against unexpected losses. This can improve a business's financial performance and provide additional funds for reinvestment or growth.

One way a small business can intentionally carry over losses is by spending money on tools and equipment towards the end of the current financial year. This is a good idea if you need specific tools to do your job and have some large, contracted work for the year ahead. Making these purchases reduces your tax bill this financial year and allows you to deduct that loss from next year's tax return.

When using carryover losses, there are some things to consider. Purposely incurring a loss can imply that the business is not performing well, which can negatively impact your ability to secure business financing. It can also create the impression that the company needs to generate more income to cover its expenses, which can signify financial trouble. Additionally, carryover losses can only be carried forward for a maximum of five years, so if the business doesn't make a taxable income within the five years, the loss will expire and will not be able to offset future taxable income anymore.

Steps to Carryover Losses

If you want to carryover losses, here are the steps you need to take for your business: 

  • Track your profit: Keep accurate records of all your business expenses, as well as your income. This will help you identify your projected tax bill, and you can decide whether to incur a loss. A tool like Thriday is perfect for this. 
  • Incur a loss: If your business is profitable and you are heading into the end of June financial year cutoff, purchase the tools and equipment needed to run your business. You'll need to spend more than you earned to create a carryover. You are all set if your business is already at a loss. 
  • Carry it over: When you lodge your tax return, you can claim your carryover losses by offsetting them against your taxable income in the current financial year. 
  • Keep accurate records: Keep records of your carryover losses, as you will need to provide this information when you lodge your tax return in future years.

It's essential to remember that the best way to save on taxes is to keep accurate records of expenses, maximise deductions and claim any credits that apply, and consult with a tax professional to ensure that you are making the most of tax opportunities.

Carryover Losses FAQs

What are carryover losses?

Carryover losses are losses incurred by a business in a particular tax year that can be offset against future income in subsequent years, reducing the amount of tax payable.

How do carryover losses work?

Carryover losses are carried forward to future tax years and can be used to offset taxable income in those years, reducing the amount of tax payable. The amount of the carryover loss that can be used to offset future income may be subject to certain limitations and rules.

What types of losses can be carried over?

Generally, any tax-deductible business expense that results in a loss can be carried forward. This includes expenses such as depreciation, bad debts, and certain capital losses.

How long can carryover losses be carried forward?

The period for which carryover losses can be carried forward varies depending on the type of loss and the relevant tax laws. In Australia, for example, most losses can be carried forward indefinitely, while some losses may have a limited carryforward period.

Can carryover losses be transferred to another business?

In some cases, carryover losses may be transferable to another business in a group. For example, if a company owns another company and the subsidiary incurs losses, those losses may be able to be transferred to the parent company to offset taxable income.

How do businesses claim carryover losses?

Businesses can claim carryover losses by including them in their tax return in the relevant year. The tax office carries the losses forward automatically, but businesses need to ensure they are appropriately tracked and recorded in their financial records.

What are the benefits of carryover losses?

Carryover losses can help businesses reduce their tax liability and improve their cash flow in subsequent years. They can also help businesses recover from difficult periods and continue to operate in the long term.

Are there any limitations on the use of carryover losses?

There may be certain limitations or restrictions on the use of carryover losses, such as the need to satisfy specific tests or requirements. Businesses need to understand the rules around carryover losses and seek advice from a tax professional if necessary.

Carrying over a loss can be an intelligent way to reduce the tax a business must pay in future years. Still, it's also important to consider the potential disadvantages before deciding. To carry over a loss, you'll need to make less than you spend, keep accurate records and lodge a carryover when submitting your tax return. Carryover losses are an increasingly popular way for businesses to smooth out their financial situation and set their business up for future success.

DISCLAIMER: Team Thrive Pty Ltd ABN 15 637 676 496 (Thriday) is an authorised representative (No.1297601) of Regional Australia Bank ABN 21 087 650 360 AFSL 241167 (Regional Australia Bank). Regional Australia Bank is the issuer of the transaction account and debit card available through Thriday. Any information provided by Thriday is general in nature and does not take into account your personal situation. You should consider whether Thriday is appropriate for you. Team Thrive No 2 Pty Ltd ABN 26 677 263 606 (Thriday Accounting) is a Registered Tax Agent (No.26262416).

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