What are tax deductions? A guide for small businesses

What are tax deductions?

Tax deductions are expenses that can be claimed against your taxable income. Self-employed individuals and businesses can claim tax deductions on their tax returns to reduce their taxable income and, therefore, pay less tax. 

The Australian Taxation Office (ATO) allows taxpayers to claim deductions for expenses that are incurred in the course of earning assessable income. There are many expenses that can be claimed as tax deductions, including work-related expenses, self-education expenses, and charitable donations.

How do tax deductions work?

Tax deductions work by reducing your taxable income. For example, if you earn $50,000 per year and have $5,000 in tax deductions, your taxable income will be reduced to $45,000. This means you will only pay tax on $45,000 rather than $50,000, which may result in a lower tax bill.

For small businesses, tax deductions can reduce your taxable income, which may result in a lower tax bill. This can free up more money to put towards other financial goals such as paying off debt, saving for a house or retirement, or investing.

To maximise tax deductions, it’s important to keep accurate records of all expenses that may be eligible for tax deductions. This includes keeping receipts, invoices, and other documentation. To avoid common tax mistakes, ensure that the expenses are legitimate and directly related to earning income.

Tax deduction programs for Australian small businesses – 2024 update

Instant Asset Write-off

The Instant Asset Write-off is a temporary Australian government program designed to help small businesses with cash flow management and encourage investment in equipment. It allows eligible small businesses to immediately deduct the full cost of eligible assets costing less than $20,000 from their taxable income in the year the asset is first used or installed. This means that small businesses don’t have to spread the deduction out over several years through depreciation, which can help cash flow.

Small businesses that qualify for the Instant Asset Write-off should have an aggregated annual turnover of less than $10 million. Generally, any depreciable capital asset used for business purposes qualifies, including computers, equipment, furniture, and some vehicles.

This is a temporary program by the ATO. As of May 6, 2024, it applies to assets used/installed between July 1, 2023 and June 30, 2024.

Energy Efficiency Bonus Deduction

The Energy Efficiency Bonus Deduction is an Australian government program that encourages small businesses to invest in technologies promoting energy efficiency. Eligible small businesses claim an additional 20% deduction on the cost of qualifying energy-efficient assets in the year the asset was first used or installed.

To qualify, your small business must have an annual turnover of less than $50 million. Examples of energy-efficiency business assets include eco-friendly heating and cooling systems, energy-efficient or induction equipment, and battery storage or heat pump systems.

The cap on the total expenditure qualified for the bonus deduction is currently $100,00 pre-GST. If your case exceeds the cap, you may be eligible for a maximum bonus deduction a business can claim, which is $20,000.

Like the Instant Asset Write-off program, this is a temporary program. As of May 6, 2024, it applies to upgrades that are first used or installed and ready for use between 1 July 2023 and 30 June 2024.

What are tax-deductible items?

Tax-deductible items are expenses that you can subtract from your gross income when calculating your taxable income. This means that they reduce the amount of tax you owe as a business.

Tax deductible items for employers may relate to employee wages & superannuation contributions, training costs, work-related travel expenses, motor vehicle expenses, entertainment expenses, gifts and donations. Employers may be able to claim tax deductions that relate directly to earning income for their business versus private use.

Common tax-deductible items for small businesses 

Not all expenses qualify for deductions. Below are the most common tax deductions for small businesses, but remember that some types may have specific limitations and record-keeping requirements.

Cost of goods sold (COGs)

Cost of Goods Sold (COGS) is a crucial tax-deductible expense for small businesses that sell products. For example, a t-shirt business has expenses for raw materials, labour wages, and manufacturing overhead. These directly reduce the business’s taxable income.

COGS applies to the cost of goods you’ve already sold. Inventory you haven’t sold yet isn’t included in COGS calculations. Maintain proper record-keeping of receipts and invoices to calculate it correctly.

Rent and utilities

Rent and utilities are expenses for your business premises, often including electricity, water, internet, and even garbage collection. You can deduct the full amount of your business rent and utilities in the income year they were incurred. If you use a portion of your home for business (home office), there are specific rules for claiming a portion of those related expenses.

Marketing and advertising

Generally, any ordinary and necessary expense you incur to promote your business and attract new customers is considered tax-deductible. This includes traditional and online advertising expenses, such as magazine ads and website maintenance.

Business asset depreciation

Depreciation accounts for the gradual wear and tear of certain assets over their useful life instead of deducting the entire cost in the year they were purchased. For example, instead of deducting the entire cost of new equipment, depreciation allows you to spread out the deduction over a number of years.

Generally, tangible assets used for income-generating purposes in your business qualify for depreciation. Some examples are computers and laptops, office furniture, machinery, and renovations.

There are different methods for calculating depreciation, such as the diminishing value method and the prime cost method. Consulting a tax advisor can help you choose the most appropriate method for your situation.

Prepaid business expenses

Prepaid business expenses are paid for in advance of goods or services your business will use in the future. However, the benefit from the expense must be received within 12 months of when it was paid for.

Examples of prepaid business expenses include annual subscriptions for software, services, or memberships; insurance premiums; and professional fees from lawyers, accountants, or consultants.

Business account and loan expenses

Generally, monthly bank account fees, transaction fees, and EFTPOS terminal fees are tax deductible. The fees must be related to the operation of your business account. Interest paid on business loans (not the principal amount) also falls under this category. In some cases, fees associated with setting up a business loan (origination fees, application fees) might also be tax-deductible.

If you use a loan for mixed personal and business purposes, only the portion used for business is tax-deductible.

Home office expenses

If you work from home, you can claim a deduction for a portion of home office expenses if you regularly use a dedicated part of your home for business purposes. This dedicated space must be specific for business use, not just occasional tasks. You must have incurred expenses working in this space, and you need records to prove these expenses.. A corner of a room you also use for personal purposes wouldn’t qualify.

You can calculate home office expenses through the fixed rate method or the actual cost method.

Fixed Rate Method

• Claim a set rate of 67 cents per hour you work from home.
• Covers expenses like internet, phone usage, electricity, and stationery.
• No dedicated home office space is required.
• You can’t claim a separate deduction for these covered expenses.
• You can still claim a separate deduction for the decline in value of work-related furniture and equipment (over $300 or part of a set exceeding $300).

Actual Cost Method

• Claim the actual expenses you incur due to working from home.
• This includes a decline in the value of furniture/equipment, utilities (electricity, gas), internet, phone usage, stationery, and cleaning (for a dedicated home office).
• You need to fairly split the costs between personal and work use for shared expenses (like utilities).
• In limited cases, you might claim occupancy expenses (rent or mortgage interest) for a dedicated home office.

Make tax deduction lodging every EOFY a breeze with Payroller

When claiming tax deductions for the end of financial year, it’s important to be aware of the ATO’s guidelines and regulations. Claiming inappropriate or excessive deductions can result in fines or penalties. Therefore, it’s important to ensure that all expenses are legitimate and directly related to earning income. It’s also crucial to keep accurate records and seek advice from a tax professional if you’re unsure.

As an employer, you can add tax deductions for specific employees in a pay run using Payroller software.  This feature is especially helpful for the self-employed or micro-employers.  Try Payroller for free today.