Video transcript - Working out your income tax
Australia's income tax system works on the self-assessment principle. This means the ATO initially accepts that the information you provide is accurate and works out the tax you are liable to pay on this basis. However, they may ask you to show records to support your information, so it‘s important to keep the necessary records to verify your claims.
The ATO works out your individual or business income tax based on your taxable income using a formula. Here’s how it works - take your assessable income, minus allowable deductions, and that equals your taxable income, or the amount you pay tax on. So, what is assessable income? Well it’s most of the money you receive in carrying on your business. That includes income such as amounts received from selling trading stock or providing services. You’ll need to include your gross earnings or proceeds, not just your profit.
However, there are some amounts you don’t include in your assessable income. That can include money you contribute as the business owner, GST (goods and services tax) you’ve collected and any money you have borrowed.
You can claim a deduction for most expenses you incur in carrying on your business. For example you can generally claim an immediate deduction for expenses that are necessary for the everyday running of your business such as advertising, electricity costs and business travel expenses. You can claim a deduction over a number of years, commonly called ‘depreciation’ for other expenses - for example, capital assets such as machinery, tools or computers.
However, there are some expenses you incur that you cannot claim. This includes loans the business takes out, or money you draw or borrow from the business as the business owner.
You also cannot claim private or domestic expenses such as travel for a holiday or private use of a computer, and GST you pay if you can claim it as a credit on your activity statement.
You pay your business tax using ‘pay as you go’ or PAYG (pay as you go) instalments. In your first year of business, you generally don't pay PAYG instalments. But after you lodge your first tax return showing a profit from business or investment income, the ATO will send you a letter if you must pay PAYG instalments. The letter and additional information will tell you your payment options and how often to pay - usually quarterly, but you may be able to pay annually. Once you enter the PAYG instalments system, the ATO will credit any instalments you pay during the year towards your final tax assessment after you lodge your tax return.
In my first year running the business I had to be careful and really budget for the total income tax that I was liable to pay. I found a good tip was to make voluntary payments to the ATO based on my estimates. Last thing I wanted was to worry about not being able to meet my tax liabilities at the end of the year!
Soon after starting business, you should be in a position to work out your taxable income periodically - perhaps weekly, monthly or quarterly. Just remember to use the formula I showed you earlier - assessable income minus allowable deductions equals taxable income. You can use weekly, fortnightly or monthly PAYG withholding tables to see how much tax you need to put aside. These are available from the ATO’s website.
You generally pay a different tax rate for different brackets of your taxable income. Here’s an example of how Jason would work out his tax payable. For current tax rates please check the ATO website. Let’s say Jason has a total of $60,000 of assessable income, his allowable deductions are $19,900, and therefore his taxable income is $40,100.
To work out the tax he would have to pay, Jason would apply the tax rates for that particular year to each relevant bracket of his taxable income.
For example, on the first $18,200 he might have paid zero tax. On the next $18,800, that is, the taxable income from $18,201 to $37,000, the tax rate could be 19% and on the next $3,100, that is, until he reaches his taxable income of $40,100, the rate could be 32.5%.
Jason would also pay a Medicare levy, let’s say 1.5% of his taxable income of $40,100, which would be $601.50. The total tax and Medicare levy that Jason would be assessed is $5,181. Now let’s have a look at how Mary would work out her company’s tax return. Nuw Cafe Pty Ltd has assessable income of $165,000 and allowable deductions of $152,000, including a salary of $36,000 paid to Mary. Mary includes these amounts in the company's tax return.
Mary works out the company's taxable income for the year by taking away the allowable deductions from the assessable income. To work out the amount of tax on that taxable income Mary then applies the company tax rate of say 30% to the taxable income.
Mary would then report her salary of $36,000 on her individual tax return. The salary will form part of her assessable income and Mary will pay tax on her taxable income at the rates for individuals. Any tax the company withheld from Mary’s salary under pay as you go withholding will be credited towards Mary’s tax liability.
Now, let’s talk about tax losses. You incur a tax loss when the total deductions you can claim for an income year are more than your total assessable income. As a sole trader or partner, if you make a loss from your business, and you have income from other sources, such as income from salary or investments, you can claim that loss by offsetting it against your other income if you meet certain criteria. Now, let’s talk about tax losses. You incur a tax loss when the total deductions you can claim for an income year are more than your total assessable income. As a sole trader or partner, if you make a loss from your business, and you have income from other sources, such as income from salary or investments, you can claim that loss by offsetting it against your other income if you meet certain criteria.
If you don't meet the criteria, you can't offset your business loss against any of your other assessable income for that income year. However, you can defer the loss or carry it forward to future years. If your business makes a profit in a following year, you can offset the deferred loss against the amount of this profit.
There are special rules for companies and trusts. For more information, speak to your tax agent or visit the ATO’s website.
This video explains how tax is calculated on your business profits, how the pay as you go (PAYG) instalment system works and what happens when you make a business loss.