For many Australian sole traders, understanding your tax return and how your income is taxed will help you to make informed decisions about your money.
The Australian income tax system is based on the self-assessment principle. This means the Australian Taxation Office (ATO) initially accepts that the information you provide to them is accurate and works out the tax you are liable to pay on this premise.
However, they may ask for records to support your claims. So, it is important to keep the necessary records to verify the information.
The ATO calculates the individual or business income tax based on the taxable income using this formula: the assessable income minus allowable deductions. The result is the taxable income, or the amount that you’re liable to pay tax on.
Assessable income is most of the money you receive in carrying on your employment/business. That includes income such as amounts received for providing services or from selling trading stock. You will need to include the gross earnings or proceeds, and not just the profit.
Still, there are some amounts that do not need to be included in the assessable income. That can be personal funds that you’ve contributed as the business owner, GST you’ve collected, and any money borrowed.
A business owner can claim a tax deduction for most expenses incurred in running a business. For instance, an owner can typically claim an immediate deduction for expenses that are necessary to run their business such as electricity costs, advertising, and business travel expenses.
In addition, a deduction can be claimed over a number of years, also known as ‘depreciation’, for capital expenditure such as machinery, computers, tools, or capital assets.
However, there are payments where you cannot claim a deduction. This includes your drawings or money lent from the business to family members.
One also cannot claim deductions on private or domestic expenses on their tax return. This includes travel for a holiday, personal use of a computer, and Goods and Services Tax (GST) they pay if they can claim it as a credit on their activity statement.
Pay as you go (PAYG) instalments
Business tax is paid using ‘pay as you go’ (PAYG) instalments. Generally, PAYG payments are not required in the first year of business. However, after lodging the first tax return that shows a profit from the business or investment income, the ATO will send a letter advising if the owner should pay PAYG instalments.
PAYG instalments are usually done every quarter and you may have the option of paying annually. The letter and additional information from the ATO will state the payment options and how often to pay.
Once you are part of the PAYG instalments system, the ATO will credit any instalments you pay during the year towards your final tax assessment after lodging your tax return.
New business owners should be careful with their budget. Make sure to have money set aside for the total income tax to be paid. The last thing you want to worry about is not being able to meet your tax liabilities at the end of the year. A good tip is to make voluntary payments to the ATO based on your estimations.
After a few months in the business, the owner should be able to calculate the taxable income periodically. This can be done weekly, monthly, or quarterly. Just remember the formula – assessable income minus allowable deductions equals taxable income.
There are PAYG withholding tables on the ATO website where you can see how much tax you need to put aside. The tax rates for different brackets are also available.
A tax loss occurs when the total deductions one can claim for an income year are greater than the total assessable income.
Should you make a loss from your business as a sole trader and have income from other sources such as income from salary or investments, you can claim that loss by offsetting it against the other income, if you meet the ATO’s criteria.
If their criteria cannot be met however, the business loss cannot be offset against any of the other assessable income for that income year.
Nonetheless, deferring the loss or carrying it forward to future years is possible. If a profit is made in a following year, you can offset the deferred loss against the amount of that profit.
You can also contact a Chan & Naylor tax accountant here to make sure you are getting all the tax deductions and offsets you’re entitled to on the tax return.
Source: Australian Taxation Office
Cindy Su is the Managing Partner of Chan & Naylor Pymble for a decade specialising in property and business related tax advisories and planning.