For many self-employed tradies, setting up your business and understanding the tax system can be complex, time-consuming, and costly, especially when you need to engage financial expertise from a tax accountant.
There are few common mistakes the team at Hnry frequently encounters, which, if addressed, could take a lot of the stress out of doing your tax and maximise the number of deductions you can claim. Here’s a list of the five of the most common tax mistakes self-employed tradies make.
Mistake #1 - Registering as a company (when operating as a sole trader is better)
Many tradies mistakenly believe that having a company protects them from personal debt liability…or that it is necessary to have a Pty Ltd company set up to undertake projects and take on sub-contractors. However, unless you are looking to raise capital for your business or partner with one or more others in the business, a Pty Ltd structure isn’t essential.
In fact, in many cases it will be worse for you. Here’s why:
Companies cost more to set up
Setting up as a sole trader is much simpler and less expensive than setting up a company. You can do it for under $40 if you want to register a business name (and completely free if you don’t!). All you need to set up as a sole trader is to get an ABN (free), register your business name ($37 for one year or $88 for three), and set up separate business accounts, then away you go.
Conversely, if you want to set up as a company, you need to register your company ($512 for a Pty Ltd), get your free ABN, then reserve your business name ($52) and then finally register it ($37 for one year or $88 for three).
Companies generate more financial admin
While registering a company for under $1,000 may not seem like a deal-breaker, companies also have far more rigorous reporting requirements, which can be a bit of a pain if you don’t need to do it.
A sole trader has a much simpler business structure and therefore has much less admin and paperwork attached to it. For example, as a sole trader:
- All your income and expenses can go on your personal tax return (using a separate Business schedule);
- You are only required to keep your financial records for five years (versus seven as a company); and
- You can still use the services of sub-contractors (with their own ABNs).
Company reporting structures are significantly more complex than they are for sole traders. The additional hurdles include:
- Reporting on performance and your financial position;
- Potentially requiring to have your financial records audited; and
- Being subject to an annual review by ASIC.
Companies also need registered officers, regular company meetings, written records of meetings and resolutions, and must register a “principal place of business”. Shutting down or closing a company is also a lot more complex.
Companies don’t protect you from bad debt liability
As a sole trader, you are liable for all debts incurred. That probably doesn’t come as a surprise.
But in most cases it’s no different if you’re the lone director of a company. The company structure doesn’t protect you from liability - both your creditors and the ATO can pursue company directors personally for company debt as well as PAYG and superannuation debts.
Drawing money is more complicated for companies
As a sole trader, you can draw money directly from your business account as the ATO doesn’t distinguish between personal and business assets.
Company Directors, however, cannot make personal drawings from the company bank account but may receive money via shares, dividends or loans. All assets are owned by the company rather than the directors or shareholders. The ATO has some excellent resources to read to understand the difference; but why bother with a more complex structure if you don’t need to?
Mistake #2 - Not Claiming all the Deductions you are Entitled to
It’s worth having a good idea ahead of time what you’ll be claiming as a tax deduction, rather than keeping the proverbial shoebox full of scrappy receipts until year’s end.
And the list of potential deductions available to self-employed tradies is pretty extensive.
Clothing - you can claim work clothes, uniforms, and protective gear (gloves, masks, goggles, boots, etc.) used solely for work.
Equipment purchased - any equipment used for work (tools), computers, printers, mobile phones and vehicles can all be claimed as a tax deduction. More expensive items may be eligible for accelerated depreciation (also called temporary full expensing) due to Government pandemic stimulus initiatives, but it’s worth speaking to your tax agent before jumping into that big purchase.
Equipment hired - any equipment you hired for a work project is also tax-deductible.
Vehicle expenses - you can claim vehicle expenses proportionate to its use for work purposes. If you use your vehicle only for work, then 100 percent of running costs are tax-deductible. If it’s used for both private and business purposes, then calculating your vehicle expenses can get a bit more complicated (see mistake #3 below!).
Administrative expenses - you can claim all your admin costs as well - that includes phone bills, subscriptions for software or publications, training courses, insurance, advertising and home office expenses (such as power and internet payments).
Materials - you can claim the cost of materials required for a job even though the customer ultimately pays for the project (examples include wood, nails, pipes and wiring).
Subcontractors - you can claim the cost of subbies you bring on to your jobs. They can be claimed as a non-taxable amount (added to an invoice) or as a client chargeable expense (where your client directly pays the subcontractor).
Mistake #3 - Miscalculating your vehicle expenses
Many sole traders trip up when it comes to vehicle expenses, especially when the vehicle is used for both private and business purposes. Assuming your vehicle is classified as a car - meaning it’s designed to carry less than one tonne and fewer than 9 passengers - then there are two methods you can use to calculate your vehicle expenses:
Cents per kilometre method - If you traveled less than 5,000 km for business purposes, you can use the cents per kilometre method to claim a fixed amount per kilometre traveled.
- Under the cents per kilometre method you claim a flat expense per kilometre traveled by the car (instead of using receipts to calculate the actual costs and fees incurred).
- To calculate the value of the deduction, multiply the number of kilometres traveled for business by 72 cents (the ATO’s rate per kilometre from 1 July 2020).
- This method includes depreciation, meaning you can’t raise a separate expense for the car’s depreciation.
- Under this method you can claim up to 5,000 kms per year on a single car without needing a logbook - all you need to do is be able to show how you worked out your business kilometres.
- For any claim exceeding 5,000 kms in a tax year a logbook is required.
Logbook method - You can keep a logbook of your travel and expenses and claim back a percentage of the total based on work usage.
- Under the logbook method, you can claim the business-use percentage of each car expense - provided you keep a detailed logbook of every business journey taken with the car.
- The logbook must have a clear record of:
- when the logbook period begins and ends;
- the car’s odometer reading at the start and end of the logbook period; and
- details of each journey including: the start date and finishing date; odometer readings at the start and end of the journey; total kilometres travelled; and the reason for the journey.
- You must keep the logbook for a period that is representative of your travel throughout the year (the period must be a minimum of 12 continuous weeks).
- How to calculate your expenses under the logbook method:
- First, use the logbook to determine the percentage of the car’s travel used for business.
- Multiply that percentage by your total car expenses to find your claimable amount.
Mistake #4 - Not setting enough aside for taxes
Most sole traders experience an unexpected tax bill or shortfall in their career. To avoid getting into that situation, it’s essential that you set the right amount of money aside from every payment you receive.
To do this correctly, you need to have a reasonable estimate of how much income you will earn in the tax year. If you have a good estimate, then any calculator worth its salt will be able to tell you what percentage to set aside from every payment for income tax.
But, of course, there’s more than just income tax.
On top of your income tax, you also need to:
- set aside 2% of your income for your Medicare levy
- add 10% to every invoice for GST (and then set that money aside) if you’re above the $75,000 income threshold
- determine whether you need to repay any study or training loans (such as the Trade Support Loan)
- work out if you need to pay Medicare Levy Surcharge if you’re not covered by the right health insurance
Proactively setting aside the right amount of taxes throughout the year will give you peace of mind going into the end of the financial year. You’ll have confidence that you won’t be surprised at the end of the tax year and be forced to dig into your savings.
Mistake #5 - Trusting a shady accountant
It’s tempting to go with an accountant who tells you they can get you “extra” deductions - even those that aren’t strictly kosher.
But at the end of the tax year, that same accountant will show you your tax return and get you to sign it - and that signature makes you liable for any incorrect information contained in it.
If the ATO audits you and finds questionable claims, the final liability and any penalties will be yours to bear - not your accountant’s.
What you get with Hnry
As a sole trader, Hnry will automate your tax obligations so you’ll never think about tax again.
Automatic tax calculations and payments
Whenever you get paid, Hnry automatically calculates, deducts and pays all of your taxes on your behalf, so you’re always up to date on your tax payments. Income tax, GST, Medicare, and student loan - all calculated and paid as you earn!
All expenses reviewed and all tax returns lodged by our accountants
As part of the service, Hnry’s accountants will review all of your expenses and then lodge your returns whenever they’re due.
As a sole trader, you get complete confidence that your taxes are done correctly - and on time!