Many people hear about tax deductions but don’t precisely understand how tax deductions work in Australia.
So the obvious question is, how do tax deductions work?
In a nutshell, tax deductions can assist with increasing your tax refund. As a business owner, you can claim a tax deduction for the majority of expenses you incur in running your business, as long as they are directly correlated to earning your taxable income. But what constitutes an eligible deduction for work-related expenses?
Note: this guide is only relevant for tax advice in Australia
Contents
How Do Tax Deductions Work?
Firstly, it’s essential to address the most significant misunderstanding about tax deductions – that claiming a tax deduction does not mean you get the entire cost back from the Australian Tax Office (ATO) when you lodge your tax return.
Instead, tax deductions can reduce your assessable income, which means you only get part of the cost back for deductible items.
So, that leads to the question – how much can you get back for your business expenses and what constitutes a work-related expense?
Generally, you can claim a deduction on the following:
- Operating expenses (such as business travel expenses, rent, insurance, office and home office expenses) in the same year you incur them
- Capital expenses (such as equipment and machinery) over a long period unless the business uses the small business asset write off of under $30,000.
Small businesses are subject to a company tax rate of 27.5%. Let’s use an example to help you understand better how using your tax deductions can help you with increasing your tax return:
Download our FREE Guide for Eligible Tax Deductions
Scenario 1 – No deductions
ABC Business earns $110,000 and retains a business profit of $110,000. Based on these figures, see below a breakdown of tax owed:
Business Income: $110,000
Profit: $110,000
Tax Payable (based on 27.5%): $30,250
PAYG Income Tax: $30,000
Final Tax Payable: $250 Payable
You might also be interested in our Definitive Guide to Business Tax Deductions for Contractors
Scenario 2 – $10,000 Tax Deduction
ABC Business earns $110,000 and retains a business profit of $100,000. $10,000 of which are a direct result of operating and capital expenses that can be tax deductible for the business such as a purchase of new equipment. Now, see below a breakdown of tax owed:
Business Income: $110,000
Less: Tax deduction ($10,000)
Profit: $100,000
Tax Payable (based on 27.5%): $27,500
PAYG Income Tax: $30,000
Final Tax Refund: $2,500 Refundable
Based on claiming $10,000 worth of business tax deductions, you can receive a tax refund of $2,500 with the 27.5% tax rate – a significant difference of $2,750 to Scenario 1.
Conclusion
Hopefully, after reading this article, you have a better understanding next time someone asks, “how do tax deductions work?”
The two most important points to understand are that you don’t get all of the business expenses back, only the tax portion of the expense. A large part of small business owners believe it’s the former and end up over-spending on their expenses.
Secondly, by increasing the level of tax deductions, you’re able to either minimise your tax payable or potentially even increase your tax refund in specific scenarios – a convenient understanding to have when operating your business.
To find out how Box Advisory Services’ small business accountants can help you with maximising your business tax deductions, book in a free appointment with us to find out more.
Sign up to our monthly newsletter where we share exclusive small business and contractor advice!
Disclaimer:
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.
