Small businesses are vital to the Australian economy, providing employment opportunities and contributing significantly to the nation’s economic growth.
Despite the exciting prospects of owning and operating a small business, the journey takes work. Small business owners must navigate complex challenges, including fierce competition, limited resources, and regulatory compliance.
Thankfully, the Australian Taxation Office (ATO) recognises the importance of small businesses and offers various tax incentives to make things easier to support and encourage growth.
Among these incentives is the Small Business Income Tax Offset, which helps eligible small businesses reduce the amount of tax they owe.
In this article, we’ll explore the small business tax offset and how it helps small businesses boost their cash flow and minimise tax liability.
What is the Small Business Income Tax Offset?
The Small Business Income Tax Offset (otherwise known as the unincorporated small business tax discount) is a tax incentive program designed to support small businesses, sole traders and those who generate their business income through trust structures and partnerships across Australia.
Essentially, it allows eligible small businesses to reduce the amount of tax they owe by up to $1,000 per year.
Who is Eligible to Claim the Offset?
To qualify for the small business tax offset, a small business must:
- have an aggregated turnover of less than $5 million, and
- be an individual carrying their small business entity as a sole trader, or
- be a partner in a partnership that the ATO considers a small business entity, or
- be a beneficiary of a trust that the ATO considers a small business entity
Company structures don’t qualify for the small business tax offset as they benefit from various other tax incentives from the ATO.
How Do You Calculate the Offset on Your Net Small Business Income
The ATO calculates the offset as a percentage of the tax payable on the business’s total net income, with a maximum limit of $1,000.
So, eligible small businesses can reduce their tax liability by up to 16% of the tax payable on their total net small business income or $1,000, whichever amount is lower.
You can usually complete the calculation in three steps:
Step one: Establish what portion of your income relates to your business. For example, if you generate other assessable income through investments or if you have net capital gains, you’ll need to determine the investment and business portions of your income.
*Note that the small business tax offset can also apply to net foreign business income if you’re an Australian resident.
Step two: Calculate how much tax you will pay on the business portion. So, let’s say 85% of your taxable income relates to your business income. If so, you can calculate the offset on 85% of your taxable income.
*Note that your small business income can’t exceed your taxable income. So, if your small business income is $75,000 and your total taxable income is $60,000 due to a negatively geared investment property, the ATO will cap your percentage proportion at 100% (not 120%).
Step three: Calculate the tax offset by multiplying 16% by the business portion of your total tax liability.
Let’s consider an example to understand how the small business tax offset works.
Meet Sarah, a sole trader who owns a small business entity. During the 2022/23 financial year, Sarah’s taxable income is $70,000, with a basic income tax liability of $13,217. She also earned $35,000 as her total net small business income.
To determine the amount of her small business income tax offset, Sarah would first calculate the percentage of her taxable income related to her total net small business income. She does this by dividing her total net small business income by her taxable income ($35,000/$70,000 = 0.5).
Based on the calculation, Sarah’s small business accounts for half of her taxable income.
Sarah would then multiply the result of the first calculation by her basic income tax liability (0.5 x $13,217 = $6,608.50).
So, according to this calculation, Sarah’s small business income accounts for $6,608.50 of her basic income tax liability.
Sarah’s small business tax offset equals 16% of the result of the second calculation (0.16 x $6,608.50 = $1,057.36).
Since this amount exceeds the maximum offset available, Sarah’s small business tax offset is capped at $1,000.
How Do You Apply For this Small Business Tax Offset?
Small business owners don’t need to apply for the offset separately; you only need to lodge your tax return with the ATO, and they will automatically calculate the offset if you are eligible. However, navigating the tax laws and regulations can be challenging, especially for business owners unfamiliar with taxation requirements.
That’s where KNS Accountants and Business Advisors can help.
Our team of experts can provide professional guidance and assistance with your tax return to ensure that you take advantage of all available tax incentives and minimise your tax liability.
Small businesses are the backbone of the Australian economy, and the ATO recognises their important role in driving growth and creating jobs. The tax offset is just one of the many small business tax relief incentives available to eligible small business owners.
By taking advantage of this offset, small businesses can reduce their tax liability and free up cash flow to invest in their operations, expand their businesses, and create jobs.
If you are a small business owner and need assistance with your income tax return or want to ensure that you are taking full advantage of all available tax incentives, KNS Accountants and Business Advisors can help.
Contact us today to learn more about how their expert services can benefit your business.