What is the small business tax offset?

The small business tax offset is available to eligible sole traders and individuals who are assessed on the income of a small business. In this article, Director of Tax Communications at H&R Block, Mark Chapman, explains what it’s all about.

The small business tax offset is one way for some people to reduce their income tax bill. It is available to eligible individuals who are either carrying on a business as a sole trader, or who have a share of net small business income from a trust or partnership.

The offset is currently 16% of the tax on your total net small business income, having increased from 13% from 1 July, 2021, onwards. However, it is capped at $1,000 per income year (for both years), making it substantially less attractive than it might otherwise be. There is also a maximum turnover threshold, which we’ll discuss in more detail below.

→ Read more: What is a tax offset?

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 already benefited from their own tax cut in recent years, in the form of a reduction in the rate of tax applicable to small companies from 30% to 26%, and again to 25% from the current financial year – 2021/22 – onwards.

What is a small business?

For the purposes of this offset, 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 $5 million for that income year.

The small business tax offset is available to:

• individuals who are carrying on small business entities (such as sole traders)
• individuals who are not small business entities 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 foreign residents. Similarly, the small business tax offset can apply to the foreign business income of an Australian resident.

How is the offset calculated?

The small business tax offset is equal to 16% of tax payable on ‘total net small business income’, up to a maximum amount of $1,000. This recently increased from 13%, effective from 1 July, 2021.

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 an individual can receive is calculated by first determining the percentage of their 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 for 2021/22 being equal to 16% 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, (2) calculate the tax payable in total net small business income, and (3) calculate the offset.

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 ÷ taxable income
2. Calculate the tax payable in total net small business income
   If the proportion is 0.70 (i.e. 70% of the individual’s taxable income relates to net small business income), then 70% of the individual’s total tax liability is taken to represent the pre-offset tax payable on total net small business income.
   The proportion is capped at 100%. Total net small business income cannot exceed taxable income. For example, if an individual’s total net small business income is $50,000 and their taxable income is $40,000 (perhaps due to negatively-geared rental property losses), the proportion is still 100%, not 125%.
3. Calculate the offset
   For the 2021/22 year, the offset was 16% 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 its deductions for the income year.

Example

Adrian is a sole trader, meaning he is running an unincorporated 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 2021/22 income year, Adrian would first divide 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 would then multiply 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% 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 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 if you’re eligible.

If you would like professional help, H&R Block is one of many professional tax services companies that may be available to assist. It offers professional advice about the structure to set up a business and assistance with setting up a company, partnership, trust or self-managed super fund.

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