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Money / Financial management

Taxing times: Deduction basics

Given that it’s the end of the financial year, now is a good time to look at the basics of tax deductions.

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A common misconception about the term ‘tax deduction’

It’s a common misconception that when something is ‘tax deductible’, that you will get that money ‘back’. Put another way, there are understandably a lot of people who think that tax deductible expenditure will be returned to them dollar for dollar in their end of financial year tax return. Well, this is not the case!

Before you berate your accountant or tax agent, or bemoan about your smaller than expected tax return, read this article.

What is tax deductible?

As a basic premise for wage earners, tax deductible expenditure is that which is directly related to earning your income. For business owners, tax deductible expenditure is an expense which you incur in running your business. However, this basic premise is qualified and modified by a massive amount of legislation, so it is always best to discuss your tax affairs with your preferred professional adviser.

How do tax deductions work?

First of all, if you make a tax deductible purchase you won’t simply be getting the value of that purchase back from the ATO in your tax return.

"It’s a common misconception that when something is ‘tax deductible’, that you will get that money ‘back’."

What will actually occur is the reduction of your ‘taxable income’ by the value of your tax deductible purchases/expenses for that income year. Again, this basic premise is modified in certain circumstances, but the following example demonstrates the general principle:

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Example: Employee/Business Owner

In the 2013-14 income year Lucy works part-time as a PR consultant, from which she earns $80,000. Lucy’s employer withheld $20,000 from her salary under the PAYG system. Lucy also runs her own advertising business as a sole trader, and her gross business revenue for the 2013-14 income year is $70,000. Lucy has incurred business related expenses of $50,000. Lucy’s tax obligations are as follows:

Assessable Income (salary):       $80,000

Assessable Income (business):  $70,000

Allowable Deductions:              – $50,000

Assessable Income:                      $100,000

Tax payable on $100,000            $24,947 (exc medicare levy)

PAYG withheld                              $20,000

Tax owing:                                      $4,947

Lucy will have a tax bill of $4,947. This is principally because she has not yet paid tax on her business income, and the tax withheld by her employer is not enough to cover both her salary income and business income.  

Modifications

While some deductions may be available immediately, others will become available over time. Usually, these deductions take the form of depreciation. Additionally, the above examples would often be altered by a number of other considerations including, but not limited to:

  • Capital gains
  • Tax offsets/rebates
  • Prior year tax losses, and
  • Medicare levy/surcharge

Remember also that if you’re claiming certain deductions you will need to keep relevant records for up to five years.

Lodging your tax return

 

Perhaps unfortunately, tax isn’t simple. Whilst there is plenty of explanatory information publicly available, including through the ATO website, fully digesting and understanding how that information applies to your situation can be difficult.

If this is you, it generally pays to take some professional advice from a registered tax agent or tax lawyer. This advice will generally cost less than the ultimate cost of making a mistake. And, best of all, the cost of such advice almost certainly will be tax deductible – the benefit of which you are now fully equipped to appreciate.

Do you have anything to add about tax deductions?

Adam Dimac

holds a bachelor of laws with honours and is an Assistant Adviser with Avenue Solutions.

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