How not to pay tax when self-employed?
Many self-employed people earn a good living. But even if your overall annual income is strong, the flow of money is not always regular. It can be weeks or even months between paycheques.
To help with your cash flow, only make larger purchases once you've paid yourself and covered regular bills. Keep some money aside for the unexpected.
Being self-employed means, you won't have the benefit of paid holidays or sick leave. It's up to you to put money aside. Regularly saving a little extra will help you manage during quiet periods, as well as funding a well-deserved break.
Ways to save taxes as self-employed in Australia
Set up a Tax Savings Account other than Your Main Account
After being self-employed, one should have a separate savings account for tax savings and business transactions.
Having different accounts helps a great deal in handling business and personal stuff.
Some self-employed professionals have one account for everything, but it is evident that the tax money, income, and expenses, can get lost in the fray.
Setting up separate accounts will keep it hassle-free in the long run.
With every check being deposited, keep 15-20% of income to the separate savings account.
Calculate the tax payment at the end of the year and then write a check out of the account.
Claim Operating Expenses
Operating expenses are revenue expenses since they help generate income, and can be claimed every year.
One can include salaries, wages, allowances and bonuses in the calculation along with ad expenses, electricity, phone, travel costs etc.
Prepay Some Expenses This Year to Reduce Taxes
You can pay part of the taxes in advance, and you will save yourself from the hassle of paying them when you might not do as well.
You can prepay on business loans a year in advance along with office and equipment lease payments.
You can prepay subscriptions, seminars, telephone and IT services and the like.
By prepaying, you can even apply for a tax deduction while also getting discounts for paying in advance.
You might find some service provider finding ways to boost sales results before the end of June.
Consider Asset Purchases
It's important to mention that a small business that purchases an asset costing less than $6500 can still claim 100 per cent of the cost in the actual year the expense is incurred.
Even if you have not paid for the item yet, you can still claim as long as you are invoiced before June 30.
Larger capital acquisitions that have an expected life longer than one year, such as IT servers, vehicles and expensive plant and equipment, must be claimed over a number of years.
These items are claimed via accelerated depreciation of the capital value, with 15 per cent claimed in the first year (even if purchased in the last month of the year) and 30 per cent each year thereafter.
Bite the Bullet and Do Away with Bad Debts
Bad debt is a taxable sale that is unpaid for more than 12 months with no chance of recovery.
You must have noted that there have been bad debts and are written off.
Speak with the accountant about the GST impact too.
Claim for Entertainment
You can buy tickets for your favourite sports team and then show them as business expenses.
But there are numerous restrictions for claiming entertainment expenses for the business.
One must conduct business with someone you are watching the game during the event, before or after the event.
Even if the expenses match up to the criteria, it is 50% deductible.
Use Medical Insurance Deductions
One can deduct premiums for health insurance for you and your spouse, along with premiums for long-term insurance for health care.
The policy can be in your personal name and deductible for taxes.
Avoid the Hobby Trap
Do not deem your self-employment as a hobby, since although you can furnish your income, you can deduct expenses only for your income amount.
Even if you earn a profit, it is a detriment in this regard.
You have to convince the tax guys that yours is a for-profit business by keeping good records.
If you are earning from your hobby of breeding dogs, then keep it that way since hobbies are not liable to self-employment tax, else it would eat into 15.3% of net income from the same.
Use Superannuation Allowance
Use your superannuation allowance of nearly $25,000 if you are aged 60, and the $35,000 if aged above 60.
If your spouse works for the business, you can even contribute to the limit again, but allow other employer contributions that you receive too.
If you are paying employee superannuation guarantee contributions before June 25, then the amount gets to the superannuation fund account on time, and the same amount can be tax deductible this year.
Plan Ahead for Holidays
You can book tickets for your future client visits or for surveying the market in advance, and the amount spent in holidays can be shown as business cases especially if you can prove that client visits happened during the interim.
Keep records of the mileage of your car along with the purpose for each trip taken, without taking personal tours into account.
Calculate tax deductions using the standard mileage rate or stick to actual expenses.
Add your costs, and deduct them
As a self-employed professional, you can lower your tax burden by deducting business-related costs that you pay throughout the year. These costs include what you pay for equipment, business use of your vehicle, attendance at conferences and networking events, trade association memberships, and advertising and marketing costs.
Tax obligations as a self-employed business owner
It will be based on your choice of a sole trader or a company structure.
Taxation as a Sole Trader
As a sole trader, you are taxed at individual income tax rates. You report your business income in your individual tax return. The amount of tax you pay will depend on:
If you run a thriving business as a sole trader, you could pay up to 45% in tax (excluding levies). However, you will be able to take advantage of the tax-free threshold of $18,200, that apply to both sole traders and individuals.
Taxation as a Company
A company is a separate legal entity. You must report any company income in a company tax return, not your individual tax return.
There is no tax-free threshold for companies, and the tax is not calculated on a progressive scale. Instead, a flat company tax rate applies to all income generated by the company.
There are two different company income tax rates:
- the "base rate" of 27.5% that applies to companies that have an aggregated turnover of less than $50 million; and
- 30% that applies to companies that have an aggregated turnover of more than $50 million.
Unlike a sole trader, you cannot offset any tax losses against your individual income. The company's tax losses are contained within the company. However, a flat tax rate is appealing to fast-growing businesses as the tax rate remains steady despite revenue growth.
Tax Liability as a Shareholder
If your business is a company, you can distribute company profits to yourself as a shareholder by issuing dividends. These dividends will affect your yearly tax liability as they will be part of your personal income. Australia uses an imputation system to determine tax liability so that you avoid being taxed twice at the company and shareholder level.
First, your company distribute profits on which income tax has already been paid, such as when your company pays a dividend to you. Then the company has the option of passing on ('imputing') credits for the tax. That process is called 'franking' the distribution.
If your company pays fully franked dividends to you as a shareholder, you will receive franking credits for the tax already paid by the company. Therefore, you do not have to pay tax on the whole dividend. You will only pay tax if your personal tax rate is higher than the company's tax rate. Otherwise, you will receive a tax refund if your personal tax rate is below the company's tax rate.
Goods and Services Tax (GST)
Registering for Goods and Services Tax (GST) is mandatory for both a company and a sole trader if your business:
- has a turnover of $75,000 or more;
- provide rideshare services for money, such as driving for Uber; or
- want to claim fuel tax credits for your business.
If none of the above applies to your business, it is optional for you to register for GST.
If you do not register for GST, you should remember to keep a close eye on your turnover. Otherwise, the ATO may fine you with penalties if your revenue surpasses $75,000 and you fail to register.
'Small Business' Tax Concessions
If you have started out as a self-employed business owner, you can take advantage of small business tax concessions.
The small business tax concessions apply if you operate a business for all or part of the income year and have less than:
- $10 million in aggregated turnover (for all concessions except for capital gains tax concession); or
- $2 million in aggregated turnover (for capital gains tax concessions only).
The main difference between operating as a sole trader or a company for small business tax concessions is the use of capital gains tax (CGT).
CGT refers to the tax you pay on the gains and losses from capital assets. Capital assets are long-term assets, such as property or company shares. For example, if you sell shares in your company, the gain or loss is calculated by the difference between the cost of acquiring the asset and the amount you receive when you sell the asset.
Capital Gains Tax Discount for Sole Traders
As a sole trader, you can receive a 50% CGT discount on your capital gain before including it in your income in certain situations. You must have owned the asset for 12 months or more. You can reduce the capital gain after applying all the capital losses for the income year, as well as other non-applied net capital losses from earlier years.
Capital Gains Tax Discount for Companies
Unlike sole traders, companies do not have the 50% CGT discount. However, if your company is a small business entity, you could access small business CGT concessions.
Your company may be eligible for the small business CGT concessions if:
- the business has an aggregated turnover of less than $2 million; or
- the company has a total net value of assets (including any affiliated entities like subsidiary companies) that does not exceed $6 million.
The small business CGT concessions allow you to disregard some or all of the capital gains made from an active asset.
An active asset is an asset used in the course of carrying on a business, or an asset inherently connected with the business. For example, the corner store you bought to sell your candy merchandise could be an 'active asset'.
If you sell an active asset that has been continuously owned for 15 years, and you are aged 55 or over and retiring, you can disregard the entire capital gain.
If this 15-year exemption is not available, you can:
- reduce the capital gain by 50%;
- use the small business retirement exemption to reduce capital gain for amounts up to $500,000; or
- defer all or part of the capital gain for two years or longer if you acquire an active replacement asset or spent money on making capital improvements on that active asset.
The purpose of these concessions is to boost your cash flow and potentially eliminate tax payable on a business exit.
Personal Services Income
If you run your business by yourself, you should be aware of the rules concerning Personal Services Income (PSI). This is income produced mainly from your personal skills or efforts as an individual.
Your income can fall under PSI in almost any industry or profession. Examples include professionals in the financial industry, information technology consultants, engineers, construction workers and medical practitioners. If the ATO classifies your income as PSI, they will tax all the profits from your business as a wage to you. Therefore, even if you are making money through a company structure, the net outcome is similar to a sole trader.
However, if you have employees or you are selling goods, the PSI rules are unlikely to apply. You can retain any excess profits in the company to be taxed at the company rate.
Your focus should be on managing your tax and not looking at measures that will put your business under cash flow pressures in coming years, just to achieve a short-term tax advantage.
Buying unnecessary assets, upgrading cars or paying higher super contributions are pointless if it means you business will face cash flow issues.
While these tips will help you lower your tax burden, the most important step in preparing taxes is having the proper processes in place and filing on time.
As you enter a new financial year, consider seeking advice from your accountant on whether you should be moving to a corporate structure going forward.
Speak to a tax advisor to ensure your books are ready for taxes and to make sure you take advantage of all possible deductions. And use accounting and tax software, to track your expenses throughout the year and to expedite and simplify the filing process.
While you can't completely eliminate what you owe in taxes, with the right strategy, you can reduce your tax burden as a self-employed professional.