I find that a large number of business owners do not completely understand how income tax works and therefore they focus on the wrong issues. In a typical conversation their overwhelming concerns are usually:
- I don’t want to pay tax.
- How can I save tax?
- Why aren’t I getting a tax refund?
Once I help these business owners better understand how it works I can usually shift their mindset towards:
- How can I make as much money as possible?; and
- How can I budget/plan for and reduce this expense?
Income tax – How it works
I will over simplify the issue so we can focus on concepts rather than getting bogged down in figures. I am going to be focusing on a sole trader who does not have a company/trust; and will not be focusing on the following topics which will be covered in future articles in this series:
- how we can reduce income tax;
- tax refunds and how they work; and
- GST & BAS statements.
Two key points to remember:
- If you make a profit (not revenue), then you pay a certain percentage to the tax office (but it will never be more than the profit you make); and
- If you don’t make a profit … you won’t pay income tax.
A quote I use for people who sometimes struggle to understand this concept is:
“It would be great to have a $100,000 tax bill … because that means I must have earned at least $280,000 in profit”.
To understand how I came up with the above you need to be aware of the income tax rates which are listed below (I have excluded Medicare levy, private hospital cover, budget repair levy & other tax offsets for simplicity).
| Income Bracket | Tax Rate |
| $0 – $18,200 | You pay 0% for every dollar of profit earned up to $18,200 |
| $18,201 – $37,000 | You pay 19% for every dollar of profit earned between $18,201 and $37,000 |
| $37,001 – $87,000 | You pay 32.5% for every dollar of profit earned between $37,001 and $87,000 |
| $87,001 – $180,000 | You pay 37% for every dollar of profit earned between $87,001 and $180,000 |
| $180,001 and over | You pay 45% for every dollar of profit earned between $87,001 and $180,000 |
To explain this table
- If you earn $18,200 of profit you will pay $0 of tax on that income
- 0% tax on $18,200 ($0 income tax)
- If you earn $37,000 of profit then you will pay $3,572 of tax on that income
- 19% tax on $18,799 ($37,000 less $18,201 = $3,572 income tax)
- 0% tax on $18,200 ($0 income tax)
- If you earn $87,000 of profit then you will pay $19,822 of tax on that Income
- 5% tax on $49,999 ($87,000-$37,001 = $16,250 income tax) PLUS
- 19% tax on $18,799 ($37,000 less $18,201 = $3,572 income tax)
- 0% tax on $18,200 ($0 income tax)
And this concept continues as you earn more.
Income tax – Calculations
Rather than get too wound up by the mechanics I’ll put a few figures into the below table so we can better see how it works:
| Business Profit (taxable income) | 18,200 | 37,000 | 87,000 | 180,000 | 281,000 |
| Income Tax on Business Profit | 0 | 3,572 | 19,822 | 54,232 | 99,682 |
| Leftover Spending Money | 18,200 | 33,428 | 67,178 | 125,768 | 181,318 |
A couple of points that I’ll make from this table:
- Income tax is expensive!; and
- The more you earn … the more left over spending money you have!!!
The last point is too often overlooked which is why it is highlighted. Whilst income tax is expensive, the more you earn the more you will have left over to spend on holidays, housing renovations and reinvesting into your business.
Rather than fret about income tax you are best to focus your energy on:
- How can I make as much money as possible? and
- How can I budget/plan for and reduce income tax?
What should I do about income tax?
Whilst it’s great to earn a large profit, income tax is still every expensive and regularly catches business owners off guard. A couple of points you should focus on:
- Reduce income tax as much as possible
There are strategies we can undertake to minimise income tax as much as possible. Still focus on earning as much profit as you can but remember to regularly get taxation advice.
- Prepare for it!
If I told you in October 2016 that once I lodge your 2017 tax return you would have an income tax bill of $10,000 … you might not be too happy. However, in July 2017 when your tax return comes back as $10,000 payable there won’t be any surprises and hopefully you would have budgeted for this expense. This is a better scenario than having no idea and suddenly in July 2017 you are hit with an unexpected $10,000 tax bill!
I recommend to my business clients that they come and see me once a quarter. In addition to preparing your Business Activity Statement we can estimate how much your next tax bill will be and can undertake strategies to reduce this expense as much as possible.
Just remember that once the year is over there is only a limited amount that we can do to reduce your tax bill so it is better to be proactive during the year than reactive and only deal with it when preparing your tax return.
For advice and assistance with your business income tax, please contact Nieuvision on 1300 832 554.
MORE INFO:
Robert Paprzycki
Chartered Accountant
E: robert@nieuvision.com.au
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