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Making sense of income tax

By Samuel Williamson

4 min read

What you need to report, especially at End of Financial Year (EOFY), and how you lodge your annual income tax return will depend on your type of business entity, but tax doesn’t have to be taxing, or even confusing. Our simple guide has everything you need to know about income tax, regardless of your business structure.

Sole trader

This is the simplest and cheapest business structure – it is simply an individual running a business. You own the business by yourself, you control and manage the business by yourself; and you alone are legally responsible for all aspects of it.

As a sole trader, you:

  • Lodge your income tax return with the Australian Taxation Office (ATO) using your individual tax file number (TFN).
  • Pay tax at the same income tax rates as individuals, although you may be eligible for the small business tax offset.
  • Have the option to pay your income tax in quarterly pay-as-you-go (PAYG) instalments. Generally, you will need to pay instalments if you reported at least $4,000 or more of business or investment income in your latest tax return, although some exceptions apply.
  • Report all your income and expenses in your individual tax return, under the section for business items.
  • Can claim a deduction for any business expenses or personal superannuation contributions you make in the relevant financial year.

You can’t employ yourself, although you can employ other people, with all the attendant employer responsibilities (including paying superannuation). This means that amounts you take from the business for yourself are not wages for tax purposes – even if you think of them as wages – and you can’t claim a deduction for them.

However, if you’re receiving personal services income (PSI), where you’re paid mostly for your personal efforts, skills or expertise, your income may be treated differently than for a sole trader.

The income tax rate for individuals increases as your taxable income increases, but starts at 19% for those earning above $18,200.

Partnership

A partnership is when more than one person owns and runs a business and, between you, you control and manage the business, and are legally responsible for all aspects of it. The partnership’s profits are shared among the partners in a legally agreed manner.

A partnership doesn’t pay tax on its income, but it must lodge a partnership tax return with the ATO, declaring all income earned and all deductible expenses.

The partnership tax return should also show how the net income or loss was distributed between the partners, and each partner must declare their individual share of the partnership’s net income or loss in their individual tax return, whether or not they actually received the income.

Furthermore, each partner owns a proportion of any asset that is liable to capital gains tax (CGT), like property for example, and needs to calculate a capital gain or capital loss on their share of each asset. Individual partners make a capital gain or capital loss from a CGT event, not the partnership itself.

Partners can choose to pay their tax using the PAYG instalment system, too. To calculate the proportion of the partnership’s income you need to include in your total instalment income, use the ATO formula.

Companies (and not-for-profits)

Some not-for-profit (NFP) clubs, societies, and associations are subject to income tax. Examples of taxable NFPs include social clubs, certain professional associations, clubs whose main purpose is providing hospitality services for members, and political parties.

For the purposes of income tax, taxable NFPs are treated as either non-profit companies or as other taxable companies:

  • A non-profit company with a taxable income over $416 per year must lodge a company tax return
  • Taxable companies are taxed on every dollar of taxable income, and must lodge an income tax return each year regardless of their taxable income

Meanwhile, an incorporated business that trades as a company will need to lodge a company tax return, and pay tax at company tax rates – whether it is at the small business company tax rate of 28.5% or the general company tax rate of 30%.

Any payments remitted from your company to you as an individual will be reported in your own personal income tax return. For more advice on this, speak to a professional.

Trust

A trust is not a separate taxable entity, but the trustee is required to lodge a tax return for the trust.

In general, trust beneficiaries declare the amount of the trust’s income they are entitled to in their own individual tax returns and pay tax on it – even if they didn’t actually receive the income. However, a trust distribution doesn’t need to be declared if family trust distribution tax has already been paid.

Trust beneficiaries can pay their income tax in quarterly PAYG instalments, in the same way as a sole trader, although you will need to work out your proportion of the trust’s instalment income first.

Reporting and paying tax

Putting aside money for your tax bill is incredibly important, and even more so in your first year of business. During your first year, you can also pre-pay tax into your tax account or pay voluntary instalments.

When you have lodged your first income tax return, and report a tax-assessable amount above the relevant threshold, you will automatically enter the PAYG instalment system.

Most of your business reporting can be done online, including your income tax return – where you’ll report your business income and personal income, and claim expense and superannuation deductions – and your Business Activity Statement (BAS) if you’re registered for goods and services tax (GST). You can track your GST and prepare your BAS for lodgement with the ATO using accounting software, like QuickBooks Online.

Learn more about tax if you’re self- employed here.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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