There is a general misconception that running a business through a company or family discretionary trusts helps people avoid income tax, nothing could be further from the truth. When a company distributes profit to shareholders tax is paid by them at their applicable marginal tax rate.
The only time that using a company can reduce the tax paid by individuals is when profits are accumulated and shareholders never take cash out until they retire. In this case the shareholders can effectively reduce tax paid because the dividend is not added onto any other income, but this comes at the cost of the cash having to be kept in the company for many years.
Profits made by family discretionary trusts are nearly always distributed to individual beneficiaries. If the profits are not distributed, and accumulated in the trust, tax is paid by the trustee at the top marginal tax rate.
When losses are made by a company or discretionary trust they are carried forward to future years when a profit is made.
For sole traders and partnerships tax is paid on the profit made each year at the owners' applicable marginal tax rates. When business losses are made by a sole trader or partnership, and the non-commercial loss rules are passed, the loss can be used to reduce other taxable income of the owners.
Q. My husband started working for himself with an ABN during the 2015-16 tax year. He did not earn enough to pay tax so we thought there was no need to claim any deductions. He did however spend $19,000 on equipment that he needed for his self employment. Is there any way I can claim some of his deductions to increase my tax refund because technically we paid for the new items out of our joint account?
A. If your husband has an ABN he will be operating as a sole trader and therefore would pay tax on any profit he makes. Unless your husband was not employed prior to commencing business he could get a tax benefit from the cost of the equipment purchased.
As he would qualify as a small business entity the $19,000 of equipment can written off in the 2015-2016 year and added to his other costs related to running his business. These would include motor vehicle running expenses and other costs directly related to earning his income.
To offset a loss against other income he would need to pass the $20,000 turnover test. Although he may not have earned $20,000 during the 2015-16 tax year he could still pass this test if what he earned over part of the year would equate to income of $20,000 had he been operating for a full year.
Unfortunately as he set himself up as a sole trader, rather than being in partnership with you, your share of the cost of the equipment cannot be claimed as a tax deduction. If a partnership had been set up, and the turnover test passed, you could have claimed a tax deduction for your share of the loss.
Questions on small business income tax and other issues can be emailed to max@taxbiz.com.au. Max Newnham is a partner in the accounting firm TaxBiz Australia and founder of www.smsfsurvivalcentre.com.au.
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