The small business tax offset is available to eligible individuals carrying on a business as a sole trader or individuals with a share of net small business income from a trust or partnership.
The offset is currently 16 per cent of the tax on your total net small business income. However, it is capped at $1,000 per income year which makes it substantially less attractive.
Who can claim the offset?
The small business tax offset is available only to individuals.
The tax offset is not available to companies as they have benefited from their own tax cut in the form of a reduction in the rate of tax applicable to small companies from 30 per cent to 25 per cent.
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What is a small business?
In general terms, an eligible small business is an unincorporated entity which carries on a business in an income year and has an aggregated annual turnover of less than $5m for that income year.
The small business tax offset is available to:
individuals who are small business entities (such as sole traders)
individuals who are not a small business entity but who are assessed on the income of a small business entity (for example, a partner in a partnership that is a small business entity or a beneficiary of a trust that is a small business entity).
The small business tax offset is not restricted to individuals who are Australian residents. To the extent that the Australian sourced income of a foreign resident satisfies the requirements for obtaining the offset, it is available to the foreign resident. Similarly, the small business tax offset can apply to foreign business income of an Australian resident.
How is the offset calculated?
The small business tax offset is equal to 16 per cent of tax payable on ‘total net small business income’, up to a maximum amount of $1,000.
The offset is non-refundable so if the amount of the offset exceeds the individual’s tax liability, the excess amount is lost.
The amount of the discount offset is calculated by first determining the percentage of an individual’s taxable income for the income year that is ‘total net small business income’. That percentage is then applied to the individual’s basic income tax liability for the income year, with the amount of the tax offset being equal to 16 per cent of the result of that calculation, up to a maximum amount of $1,000.
The best way to illustrate this is by way of a three-step calculation:
1. Work out the proportion
Determine the proportion of the individual’s basic income tax liability that relates to small business activities using the formula:
total net small business income
2. Calculate the tax payable in total net small business income
If the proportion is 0.70 (ie, 70 per cent of the individual’s taxable income relates to net small business income), then 70 per cent of the individual’s total tax liability is taken to represent the tax payable on total net small business income.
The proportion is capped at 100 per cent. Total net small business income cannot exceed taxable income. For example, if an individual’s total net small business income is $50,000 and taxable income is $40,000 (perhaps due to rental property losses), the proportion is 100 per cent, not 125 per cent.
3. Calculate the offset
The offset is 16 per cent of the tax liability calculated in step 2. Using the figures from step 2, the offset would equal 0.16 x 0.70 x total tax liability, capped at $1,000.
A small business entity’s ‘net small business income’ for an income year is the sum of the entity’s assessable income minus it’s deductions for the income year.
Adrian is a small business entity. For the 2021-22 income year, Adrian’s taxable income is $100,000, his basic income tax liability is $25,000, and his total net small business income is $50,000.
To work out the amount of his small business income tax offset for the 2020-21 income year, Adrian first divides his total net small business income by his taxable income ($50,000/$100,000 = 0.5). The result of this calculation shows that half of Adrian’s taxable income relates to his total net small business income.
Adrian then multiplies the result of the first calculation by his basic income tax liability (0.5 × $25,000 = $12,500). The result of this second calculation shows that $12,500 of Adrian’s basic income tax liability is from his total net small business income.
Adrian’s small business tax offset is equal to 16 per cent of the result of this second calculation (0.16 × $12,500 = $2,000).
As this figure is greater than the maximum offset available, Adrian’s small business tax offset is therefore capped at $1,000.
How can I apply for the small business tax offset?
You don’t need to apply for the tax offset. You simply need to lodge a tax return for the year in question and the offset will be automatically calculated for you.
Mark Chapman is director of tax communication at H&R Block.