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17-Nov-2020 By - team

Sole Traders and tax claiming

As a sole trader, being aware of precisely what you can claim will help you ward off a large tax bill when tax time looms.

There’s a lot of complicated and conflicted information out there.

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Between the ATO website and the sites with a bunch of ads, it is so difficult to understand what it is that a sole proprietor needs to do to understand the tax implications of running their business.

As a sole trader, your business will naturally incur running costs. The good news is that many of these running costs can be claimed as business expenses, meaning you’ll pay less tax and get to keep more of your hard-earned money.

It’s easy to forget or lose track of what can and can’t be claimed as an expense, given the array of eligible items. Ultimately though, this means you could be paying more tax than you need to be.

Throughout the years, legislators have written numerous lines into the tax code to soften the blow of the extra costs that self-employed persons must shoulder as they do business. However, the 2017 Tax Cuts and Jobs Act (TCJA) eliminated several self-employed tax deductions. Many of these changes are temporary and set to expire in 2025, but others are permanent

The law affects small businesses in many ways, mainly via a complicated 20% business income deduction for pass-through businesses—those that pay taxes through the individuals rather than through the corporation.

 

How Do I Know I Am A Sole Proprietor?

Great question. It’s essential to establish if you are a sole proprietor to determine your tax obligations. This is necessary so you can calculate your deductions!  

A sole proprietorship is not limited to a specific industry. In its most basic form, a sole proprietor runs and operates their own business. It is not established as a legal entity; therefore, all the financial and legal obligations fall upon the owner. 

Even if you do projects as an independent contractor for one or two firms, it’s very likely you are a sole proprietor. Typically, companies do not withhold taxes from an independent contractor’s wages. If no one is withholding your taxes, most likely you’re a sole proprietor. 

The beauty of being a sole proprietor is the simplicity of setup. It’s by far the easiest company to start because essentially, all you need is yourself and a skillset. To give you some ideas, here is a sample of a sole proprietorship business: 

  • Computer repairs services 
  • Freelance writing or graphic design 
  • Landscaping or lawn company 
  • Photography

How Does A Sole Proprietorship Pay Taxes?

Now that you know you’re a sole proprietor, it’s essential to start thinking about taxes. We know this isn’t the most fun topic.

We’re going to break it down and help make the process a little easier. 

The easiest way to pay your sole proprietor taxes is to visit the ATO website and pay electronically. You can use either your bank account, a debit or credit card. By using your bank account, you can schedule payments in advance. Those paying with debit or credit card also have the option to call and make a payment. 

You can send a check, although online is the quickest option.

If you’re unable to meet your tax obligation, you can set up a payment plan. Note that this may include interest and late fees. 

Don’t forget to check out your state’s Department of Revenue site. They manage state sole proprietorship taxes, and that is where you will need to make your state payment. While you may owe fewer state taxes than federal, it’s essential to take care of it.

 

Allowable Deductions For Sole Traders

If your expenses relate directly to running your business and earning assessable income, you can claim them in your personal tax return.

According to the Australian Taxation Office, you can generally claim the following operating expenses in the year you incur them:

  • Advertising
  • Bad debts
  • Home office expenses
  • Bank charges
  • Business motor vehicle expenses
  • Business travel
  • Education and training
  • Professional memberships
  • Insurance
  • Interest
  • Telephone bills
  • Repairs/ maintenance
  • Tax preparation costs.

Typically, depreciation on capital expenses, which are expenses that have a longer life, is claimed over several years. Examples include:

  • Computers
  • Electrical tools
  • Furniture
  • Motor vehicles
  • Plants and equipment.

If an expense is for both business and private use, you can only claim the business portion.

As a sole trader, you cannot claim deductions for private or domestic expenses, entertainment, fines, nor costs relating to income that is not taxable, such as money earned from a hobby.

 

What Are Tax Deductions?

A tax deduction is an expense subtracted from your taxable income. Tax deductions reduce the amount you pay taxes on.

For example, let’s say you made $75,000 in income during the financial year and incurred business-related expenses worth a total of $10,000. In this case, your taxable income would be $65,000 instead of $75,000, reducing the amount of tax you owe for that year.

Accountant At Work

In Australia, most expenses related to running your business can be claimed as tax deductions.

According to the Australian Taxation Office (ATO), a business expense must meet three criteria to be claimable as a tax deduction:

  • The payment must directly relate to operating your business and not be for personal use.
  • If the payment is for both business and personal use, you can only claim the portion of the cost that is used for your business.
  • You must have records to prove it. Note that having a ‘record’ doesn’t always mean you need a receipt. 

All self-employed people, including contractors and sole traders, can claim expenses against their income.

 

What Expenses Can A Sole Trader Claim?

  • Anything you purchase, which is then used to generate business income, can be used as a tax deduction.
  • If your home also serves as a base for your business you may be eligible to claim rent/mortgage interest, rates, water, electricity and insurance expenses; however it will be prorated based on the space within the property utilised for business purposes.
  • Phone and internet – the percentage of costs that relate to your business
  • Car expenses – similarly, you may be eligible to claim a percentage of car expenses for travel to and from client sites, attending training sessions, travel to pick up supplies or post office collections to name a few.

Occupancy expenses are those you pay to own, rent or use your home. They include:

  • mortgage interest or rent
  • council rates
  • land taxes
  • house and contents insurance premiums.

 

If you run a home-based business, you may be able to claim a share of your occupancy expenses that relate to your business. To be eligible to claim a deduction for occupancy expenses, you must pass the interest deductibility test.

If you are eligible to claim occupancy expenses, you will also be able to claim running expenses. If personal services income rules (PSI) apply to your business, you may not be able to claim occupancy expenses.

 

Home Office Expenses

If you work from home some or all of the time, you may be able to claim tax deductions for home-based business expenses. This includes:

Running expenses

This covers the equipment, tools, and other physical goods you need to run your business.

  • Home office equipment, including computers, printers, phones and home office furniture.
  • Utilities, including phone, internet, electricity and gas.
  • Cleaning costs.
  • Repair costs, including the cost of repairs to home office furniture or fittings.
  • General home office costs, including stationery, printer paper and ink.

Using the fixed-rate calculation

To make calculating the cost of running expenses easier, the ATO allows sole traders to deduct a fixed rate of 52 cents for each hour you work from home.

For example, if you work 38 hours from home during a week, your allowable running expenses deduction for that week would be:

38 x .052 = $19.76

This calculation covers the cost of heating, cooling, lighting, cleaning and the decline in value of the furniture.

If you use this method, you’ll still need to separately work out all other home office expenses, such as:

  • Work-related phone and internet expenses
  • Stationery
  • The decline in value on computers or other equipment

Alternatively, you can manually calculate and deduct all running expenses. Still, you’ll need to maintain records—such as a diary of the number of hours you work from home for the year—to prove your claim is reasonable.

Occupancy expenses

This covers the non-tangible fees and costs of running a business out of your own home.

  • Rent
  • Mortgage interest
  • Property insurance
  • Land taxes
  • Council rates

Calculating occupancy expenses

If you work from home and can claim occupancy expenses, you’ll need to work out the portion of your home that you use for work purposes. You can do this by calculating:

Total costs x the percentage of your home’s floor area you use for work x the portion of the year that part of your home was used exclusively for work

For example, if the floor area you use for work takes up 20% of your home, and you worked from home all year, you can claim 20% of your total occupancy expenses as a tax deduction.

Vehicle and travel expenses

If you use a car or other vehicle for work purposes, you can claim the following vehicle expenses:

  • Fuel and oil
  • Repairs and servicing
  • Interest on a motor vehicle loan
  • Lease payments
  • Insurance cover premiums
  • Registration costs
  • Depreciation (decline in value)

Keep in mind that you can only claim vehicle expenses that relate to your business. For example, if 50% of your car use is for work, you can claim 50% of the costs above as a business deduction.

The ATO suggests using a logbook or diary to record your business versus personal vehicle usage.

Alternatively, you can also use the simplified ‘cents per kilometre method’ to calculate your vehicle deductions for the year. Using this method, you can claim 68 cents per kilometre for every kilometre travelled throughout the year, up to 5,000 kilometres.

Additionally, if you travel for work purposes, you can claim business-related expenses, including:

  • Airfares
  • Public transport or taxi fares
  • Car hire fees and related costs such as fuel, tolls and car parking
  • Accommodation costs
  • Meal costs, if you are away overnight

The ATO’s small business travel expenses guide covers what you can and can’t claim, and how to record your expenses, in more detail.

General business operating expenses

Ordinary operating expenses that can be claimed as a tax deduction include:

  • Advertising and marketing costs
  • Legal expenses
  • Accounting and tax lodgement fees
  • Bank fees
  • Insurance premiums
  • Interest on business loans
  • Software subscription fees
  • Uniform fees

Accountant Working At The Office

Repair and maintenance expenses

If you need to pay for work-related repairs and maintenance, you can claim these costs as deductions. This includes:

  • Computer or other equipment repairs
  • Machinery repairs
  • Painting
  • Plumbing work
  • Repairing electrical appliances

You don’t need to own the property or item that is being repaired or maintained to claim a deduction. However, repairs or maintenance must relate to your business.

Depreciating assets

A depreciating asset is an asset that declines in value over time. This includes:

  • Computers
  • Cars and vehicles
  • Office equipment and machinery
  • Furniture, carpet and curtains

Sole traders and freelancers with an annual turnover of less than $500 million can claim an instant deduction on assets worth less than $150,000 in the year they are purchased.

For example, if you buy $10,000 worth of office equipment during the financial year, you can claim the full $10,000 deduction in your tax return for the year.

This threshold was recently increased to help businesses withstand and recover from the economic impact of COVID-19.

See the government’s guide to the instant asset write-off for more information.These are general deductions only. For advice on which deductions apply to your business, talk to an accountant, registered tax agent or the ATO.

What Can’t Sole Traders Claim?

Like any business, you do need to tread carefully and ensure that you keep in the ATO’s good books and only claim valid business-related deductions.

Some of the most common misconceptions where sole traders can put a foot wrong:

  • You can’t claim 100% of all expenses – if you use something for personal AND business use, you must apportion the costs and keep records to support the percentage that you are claiming. EXAMPLE: mobile phone or internet costs.
  • Car expenses do require a logbook. In the majority of cases, if you are using your car for business, you need to maintain a logbook to claim actual car expenses if claiming up to 5,000km as a deduction you need to be able to provide the ATO with details of your business-related car usage.
  • Rules apply for meals and coffees depending on the situation:
    • Meals, coffees and snacks are NOT tax-deductible UNLESS incurred on business-related overnight travel and make sure you keep the receipts!
    • Meals and coffees consumed during meetings are classed as entertainment expenses by the ATO. They are NOT deductible for GST or income tax purposes UNLESS they are minor and infrequent (or you pay FBT on the expenses) – this is where getting good advice from a registered tax agent can help!
  • Travel expenses – if family or friends stay with you, only the amount relating to the sole trader can be claimed as a tax deduction, the balance is considered a personal expense.
  • You need tax receipts! Bank statements or EFTPOS receipts are not satisfactory. If you don’t have receipts to support your deductions, these will be disallowed if you get audited. Tip: make sure the receipt is legible and show exactly what was purchased to be a valid tax deduction.

 

Self-Employment Tax

The self-employment tax refers to the employer portion of Medicare and Social Security taxes that self-employed people must pay. Everyone who works must pay these taxes, which for 2019 are 7.65% for employees and 15.30% for the self-employed. Here’s how the rates break down:5 

  • 6.2% Social Security tax each for employee and employer on the first $132,900 in wages ($137,700 for 2020).
  • 1.45% Medicare tax each for employee and employer with no wage limit

 

You will owe an additional Medicare tax of 0.9% in the following situations:

Filing Status Income

Single -$200,000

Married filing jointly – $250,000

The income thresholds for additional Medicare tax apply not just to self-employment income, but to your combined wages, compensation, and self-employment income. So if you have $100,000 in self-employment income and your spouse has $160,000 in wage income, you’ll have to pay the additional Medicare tax of 0.9% on the $10,000 by which your joint income exceeds the $250,000 threshold.

Paying extra taxes to be your own boss is no fun. The good news is that the self-employment tax will cost you less than you might think because you get to deduct half of your self-employment tax from your net income. The ATO treats the “employer” portion of the self-employment tax as a business expense and allows you to deduct it accordingly. What’s more, you only pay self-employment tax on 92.35% of your net, not gross, business income. 

Remember, you’re paying the first 7.65% no matter whom you work for. And when you work for someone else, you’re indirectly paying the employer portion because that’s money your employer can’t afford to add to your salary.

DISCLAIMER
THIS WEBSITE CONTAINS GENERAL ADVICE ONLY AND IS NOT PERSONAL FINANCIAL OR INVESTMENT ADVICE. ALSO, CHANGES IN LEGISLATION MAY OCCUR FREQUENTLY. WE RECOMMEND THAT OUR FORMAL ADVICE BE OBTAINED BEFORE ACTING ON THE BASIS OF THIS INFORMATION. INFORMATION CONTAINED HEREIN HAS BEEN SECURED FROM SOURCES EWM ACCOUNTANTS & BUSINESS ADVISORS BELIEVES ARE RELIABLE, BUT MAKE NO REPRESENTATIONS OR WARRANTIES AS TO THE ACCURACY OF SUCH INFORMATION AND ACCEPT NO LIABILITY. WE SUGGEST THAT YOU CONSULT WITH A TAX ADVISOR, CPA, FINANCIAL ADVISOR, ATTORNEY, ACCOUNTANT, AND ANY OTHER PROFESSIONAL THAT CAN HELP YOU TO UNDERSTAND AND ASSESS THE RISKS ASSOCIATED WITH ANY INVESTMENT.

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