Is this expense tax deductible, or not? Here’s how to tell.

(expense – 5 minute read)

Hi there accounting fans!

One of the perks of being a business owner is the ability to claim tax deductible business expenses. This means that you can reduce your profit (and taxes!) just by spending money on your business. Woohoo! However, you need to remember that not ALL expenses are tax deductible. Deducting the wrong expenses can get you in trouble with the tax department.

To avoid this, here are two simple tests you can use to work out if an expense is tax deductible or not.

Does this expense help my business generate income?

Comic Sam ( A man in traditional Malay Outfit) looks at a Credit Unicorn plushy and thinks to himself: Will it make me money?

The first step is to ask if the expense helps generate income for your business. For example:

You purchase clothes from a wholesaler for $30 and you then sell it at retail price for $50. The $30 you spent is an expense which you have used to directly generate income. This expense passes the first test!

Another example is: you pay rent of $300 a week for your office. Your office is your place of business. Its where you meet clients, do your work and plan on how to grow your business. Indirectly, that $300 a week you spend contributes to your business’ ability to generate income. This also passes the first test.

A non deductible example would be: You’ve spent $1,000 on the latest concert ticket to your favorite band. This has absolutely no connection to your business whatsoever. It can’t, even if you stretch your imagination, be a business expense. This is NOT a business expense.

Do you derive some sort of personal benefit out of it?

Comic Sam looks at a shoe box containing a fancy shoe. He wonders to himself if there is 'Any personal benefit'?.

Here’s where things get a bit tricky. Generally speaking, 90% of business expenses can be allocated using the first test. But some expenses can have both a personal and professional portion. For example:

You do some business work from home. It costs $800 a year for the home telephone and internet bill. Working without an internet connection from home is impossible, so this expense contributes to your business income. However, since it is the home telephone and internet bill, you still use it for personal use. Your kids watch Youtube on it, your partner uses it to do home accounting and you use it to watch cat memes (which is what I do in my free time).

Another example is fuel spent on your personal car. Unless you are a tradie or work in a trade where physical travelling is essential, motor vehicle expenses may not be 100% claimable. You may only use 50% of your car for business purposes and the other 50% for personal errands. Your fuel spend still brings you some personal benefit.

In these first two cases, what you need to do is to claim the portion of which relates to your business. For telephone and internet, the general prescription is to claim 50% of any home telephone and internet spend as a business expense. With personal cars, you will need to keep a logbook to work out your business use percentage, then use that percentage to claim a portion of your fuel, repairs, insurance and other car running costs.

.1 Is it a significant personal benefit?

Some expenses will help us run the business. But they can seem to be too much of a personal benefit to make that link.

An example of this would be: You’ve paid $400 for a spa day. Business is hard and life is stressful. You need a break! Yes, a break will help you get better and make more money for your business right? Maybe, but its hard to draw a causal link between this expense and generating income for the business. This expense cannot be claimed.

Another example would be: You’re a single parent working hard to manage their business AND three young children. You pay $80 a week for a baby sitter to mind your kids while you do your work. Having the kids off your back means that you can work better. Better work equals more money! While it may help you generate income for the business, it gives you significant personal benefit. There is nothing stopping you from using your free time to go on that $400 spa day that you’ve purchased earlier (instead of actually working on the business). This expense cannot be claimed either.

A final example is: You’re going for a work conference. You need some fancy new shoes. After all, you don’t want to have shabby footwear at the biggest work conference of the year in your industry. Good looks equals to good business opportunities amirite? Unfortunately, since said fancy shoes can still be worn outside of a work context (and realistically they will be mostly used for personal use), you can’t claim this as an expense.

What about entertainment expense?

Comic Sam is opening his mouth wide, about to stuff a fried chicken drumstick into it. He asks himself 'Entertainment Expense?'.

Taking clients out for drinks, buying your team members a meal and purchasing gifts for clients. These are examples of transactions that fall under the broad category of ‘entertainment’ expenses. The general rule for entertainment expenses is that they are only 50% deductible.

In most cases, buying food for your client won’t directly generate more income for you. But it does help build that relationship and they are more inclined to spend on your business in the future. Note that buying meals for yourself alone is not claimable as an entertainment expense (see: personal benefit above). So remember, never eat out alone if you are a business owner. Always invite a client or a team member so that you can claim it as an entertainment expense!

This is just a simple guide.

There you have it, some simple ways to ensure you are claiming the correct expenses for your business. Some expenses can also depend on the type of business you are in. If you own rental properties, interest expense on mortgage repayments are getting phased out on some properties and you won’t be able to claim the full amount for tax deductions. On the other hand, if you don’t run a rental property business, interest expenses are still 100% claimable.

As your business grows, you will come across more complicated transactions that will leave you scratching your head. You may find that this guide may not be able to answer all your tax related questions. In which case, you may want to consult a tax agent to help you better claim the right amount of expenses for your business.

Happy deducting!

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