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.
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.
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:
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.
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:
Typically, depreciation on capital expenses, which are expenses that have a longer life, is claimed over several years. Examples include:
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.
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.
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:
All self-employed people, including contractors and sole traders, can claim expenses against their income.
Occupancy expenses are those you pay to own, rent or use your home. They include:
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.
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:
This covers the equipment, tools, and other physical goods you need to run your business.
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:
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.
This covers the non-tangible fees and costs of running a business out of your own home.
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:
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:
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.
Ordinary operating expenses that can be claimed as a tax deduction include:
If you need to pay for work-related repairs and maintenance, you can claim these costs as deductions. This includes:
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.
A depreciating asset is an asset that declines in value over time. This includes:
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.
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:
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
You will owe an additional Medicare tax of 0.9% in the following situations:
Filing Status Income
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.
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.
Guest post by : team Form -
Like this? Share it...