Deductions
Tax deduction
A tax deduction is an expense you can subtract from assessable income to reduce taxable income, provided it meets the legal requirements and you have the records to prove it.
A tax deduction reduces the income on which you are taxed. When you claim a deduction, you do not get a dollar for dollar refund. Instead, your taxable income falls by the amount of the deduction, and your tax falls by that amount multiplied by your marginal rate. A deduction of $1,000 at a 30% marginal rate would save around $300 in income tax.
For an expense to be deductible, it generally needs to meet three conditions. You must have spent the money yourself and not been reimbursed. It must be directly related to earning your assessable income, or to carrying on a business. And you must be able to produce records to prove it. Expenses that are private or domestic in nature, or that are capital in nature, generally cannot be claimed as an immediate deduction.
Deductions are available to both employees and business owners. Employees can claim work-related expenses, such as tools, uniforms, and certain training. Business owners can claim many costs including stock, wages, rent, insurance, advertising and depreciation. Some deductions are specific, such as donations to deductible gift recipients and the cost of managing your tax affairs.
GST interacts with deductions in an important way. If you are registered for GST and can claim an input tax credit, the deduction is for the GST-exclusive cost. If you are not entitled to claim a credit, such as when you are not registered, the deduction is for the full GST-inclusive amount. Mistakes here can cause you to claim GST twice, once as a credit and once as a deduction.
Mixed-purpose expenses must be apportioned. If you use a phone half for business and half for private purposes, only the business part is deductible, based on a reasonable method. There are also substantiation rules, which require written evidence for many expenses, with some small amounts or particular categories having relaxed rules. Keep your records for five years.
Capital items are generally recovered over time instead, through depreciation, capital works deductions or as part of the cost base for CGT. Deduction claims are examined by the ATO, and over-claiming can bring penalties and interest. This is general information only, so confirm what you can claim with the ATO or a registered tax professional.
Worked example
A GST-registered sole trader buys business supplies for $1,100 including $100 GST. She claims a $100 input tax credit on her BAS and a deduction of $1,000, the GST-exclusive cost, in her tax return. At a 30% marginal rate the deduction saves about $300 in income tax, so the net cost of the supplies after both benefits is about $700.
Practical tips
- Claim the GST-exclusive amount as a deduction if you also claim the GST as an input tax credit.
- Apportion mixed-use expenses and keep the working that supports your percentage.
- Keep records for five years, since a claim without records may be disallowed.