What Is A Tax Write Off And How Does It Work?
Under the instant asset write-off, eligible businesses can claim an immediate deduction for the business portion of the cost of an asset in the year the investment is first used or installed ready for use.
Instant asset write-off can be used for:
- multiple assets as long as the cost of each individual purchase is less than the relevant threshold
- new and second-hand purchases.
It cannot be used for assets that are excluded from the simplified depreciation rules.
The instant asset write-off eligibility criteria and threshold have changed over time. You need to check your business’s eligibility and apply the correct threshold amount. This depends on when the asset was purchased, first used or installed ready for use.
A vital feature of the 2015/16 Federal Budget (and subsequent Federal Budgets since) was the $20,000 Instant Asset Write Off scheme for small businesses. This system has proven to be very popular with Small Business Owners. The $20,000 Instant Asset Write Off scheme allows business owners to immediately write off depreciable assets that cost the business less than $20,000.
Due to the recent coronavirus pandemic, the Federal Government is expected to bring bold decision to bring forward the instant asset write-off and increase it from $30,000 to $150,000.
The Morrison Government confirmed that the write-off threshold would be lifted to $150,000 and extended to businesses with a turnover of up to $500 million, from $50 million.
The cut-off date to take advantage of the increased limit is June 30. New equipment, computer hardware, office fit-outs, furniture and vehicles are amongst the potential assets, that can be written off.
This new measure is expected to decrease taxes paid by Australian businesses by $2.5billion over the next two years.
What Does This Actually Mean?
A write-off is an expense that can be claimed as a tax deduction. Tax write-offs are deducted from total revenue to determine total taxable income for a small business.
Qualifying write-offs must be essential to running a business and every day in the business’s industry. A write-off doesn’t need to be absolute, 100 percent necessary, but it should be considered a regular expense that helps run the business,
As you know, deductions are typically available for purchases that are made by your business, for your business. The purpose of the $150,000 Instant Asset Write Off is to accelerate the speed at which you can make deductions for those purchases.
Since the commencement of the scheme, small businesses (ATO definition of small business) have been able to deduct business assets that cost $150,000 or less instantly. This allows business owners to claim a deduction for that asset in the same income year as the asset was purchased. This deduction is then able to be declared on the business’s tax return for that income year.
An instant asset write-off allows small businesses (with an annual turnover of less than $500 million) to claim immediate deductions up to an amount of $150,000 (this will reduce to $1,000 from January 1 2021) for new or second-hand plant and equipment assets purchases such as vehicles, tools and office equipment. The assets must first be used, or installed for use, in the income year you’re claiming for.
The amount you can write-off will depend on when the asset was purchased and the associated threshold amount. Thresholds and eligible turnovers changed on March 12 2020, check the ATO website for details.
A write-off is a business expense that is deducted for tax purposes. Fees are anything purchased in the course of running a business for profit. The cost of these items is deducted from revenue in order to decrease the total taxable income. Examples of write-offs include vehicle expenses and rent or mortgage payments,
Businesses regularly use accounting write-offs to account for losses on assets related to various circumstances. As such, on the balance sheet, write-offs usually involve a debit to an expense account and a credit to the associated asset account. Each write-off scenario will differ, but usually, expenses will also be reported on the income statement, deducting from any revenues already reported.
Generally Accepted Accounting Principles (GAAP) detail the accounting entries required for a write-off. The two most common business accounting methods for write-offs include the direct write-off method and the allowance method. The thresholds used will usually vary depending on each scenario. Three of the most common strategies for business write-offs include unpaid bank loans, outstanding receivables, and losses on stored inventory.
Financial institutions use write-off accounts when they have exhausted all methods of collection action. Write-offs may be tracked closely with an institution’s loan loss reserves, which is another type of non-cash account that manages expectations for losses on unpaid debts. Loan loss reserves work as a projection for outstanding debts while write-offs are a final action.
A business may need to take a write-off after determining a customer is not going to pay its bill. Generally, on the balance sheet, this will involve a debit to an unpaid receivables account as a liability and a credit to accounts receivable.
There can be several reasons why a company may need to write off some of its stock. Merchandise can be lost, stolen, spoiled, or obsolete. On the balance sheet, writing off checklist generally involves an expense debit for the value of merchandise unusable and a credit to stock.
The term write-off may also be used loosely to explain something that reduces taxable income. As such, deductions, credits, and expenses overall may be referred to as write-offs.
Businesses and individuals have the opportunity to claim certain deductions that reduce their taxable income. The ATO allows individuals to claim a standard deduction on their income tax return. Individuals can also itemize deductions if they exceed the standard deduction level. Deductions reduce the adjusted gross income applied to a corresponding tax rate.
Tax credits may also be referred to as a type of write-off. Tax credits are applied to taxes owed, lowering the overall tax bill directly.
Corporations and small businesses have a broad range of expenses that comprehensively reduce profits required to be taxed. An expense write-off will usually increase costs on an income statement which leads to a lower gain and lower taxable income.
The instant asset write-off was initially raised to $30,000 as of April 2 2019. However, in light of the coronavirus outbreak and the subsequent harm to Australian businesses, as of March 12 2020, the instant asset tax write-off has been raised to $150,000. This was initially meant to revert back to a lower asset write-off on June 30 2020, and however on June 9 2020, the government announced it would extend the $150,000 instant asset write-off until December 31 2020. As of January 1 2021, the instant asset tax write-off will be reduced to $1,000
These are measures that have been taken as a means of stimulating the economy in the face of the pandemic. This write-off is an excellent way for small businesses to make essential purchases without needing to wait to claim.
As of March 12 2020, the instant asset tax write-off has also been expanded to include businesses with a turnover of up to $500 million (up from $50 million). This is good news for companies with higher turnovers that require more extensive equipment purchases. Expanding the threshold also means that an additional 5,300 businesses who employ roughly 1.9 million Australians will now be able to access the instant asset tax write-off for the first time. Prior to March 12, companies with a turnover of between $10 million and $50 million could use the instant asset tax write-off (previously restricted to businesses with a turnover of less than $10 million).
Please note, however, that the $150,000 tax write-off and $500 million turnover threshold is only available for purchases bought from March 12, 2020, onwards. Purchases bought between April 2 2019 – March 11, 2020, will qualify for an instant asset tax write-off of up to $30,000.
The instant asset tax write-off is due to revert back to $1,000 for small businesses (turnover less than $10 million) from December 31 2020.
How Does A Write-off Work Lowering Taxable Income?
A write-off is also called a tax deduction. This lowers the amount of taxable income you have during tax time. Basically, let’s say you made $75,000 last year and have $15,000 in write-offs. That means your taxable income for the year would be $60,000.
The tax code allows self-employed workers to write off various expenses related to their business. This can include things like business miles with the mileage deduction, usual business expenses, the cost of using your home as an office and much, much more.
W-2 workers can often qualify for various write-offs, especially if they itemize their return. Many people can lower their taxable income by writing off things like charitable donations, mortgage interest deduction and more. If you don’t want to itemize, many W-2 employees can also use the standard deduction to lower their taxable income. The standard deduction varies based on your filing status, and you can see what yours would be using this calculator.
Why Are Assets Written Off?
Assets are written off because they’re no longer of value to a business.
Here are examples of situations where a write-off is necessary for small business and how it’s handled in the books:
Accounts Receivable Can’t Be Collected
A general contractor has a $2000 invoice outstanding for a small bathroom renovation job. The client hasn’t paid. Finally, the contractor hears the client is bankrupt and unable to pay the bill. Outstanding invoices are categorized under accounts receivable. The contractor debits the category “bad debt expense” by $2000 and credits $2000 to a class called “allowance for doubtful accounts,” which offsets the amount owing in accounts receivable.
Inventory Is Of No Use
Perhaps inventory is outdated, or it can’t be sold due to an error in manufacturing. The cost of merchandise can be added to the category “cost of goods sold” or its value can be offset using the obsolete inventory reserve.
A Fixed Asset Is Of No Use
Fixed assets are items of value to a company that won’t be used up within a year and are intended for long-term use. A company might buy furniture for their office. However, the company downsizes, and the owner moves back to a home office. There’s no use for this office furniture. The office furniture’s value has depreciated thanks to wearing and tear. So the depreciated value is accounted for, and the new value is charged to a loss account.
Pay Advance Isn’t Returned
A new employee is given an advance on their pay as a favour from the owner. The employee unexpectedly quits before earning out their pay and refuses to pay the rest of the advance back. The balance is then shifted to the compensation expense account.
How Is This Different From The Previous Asset Deduction Rules?
The main difference is that until May 12, 2015, businesses were only able to write off assets up to $1,000 instantly. Assets that exceeded $1,000 were only able to be written off partially every year, in accordance with the relevant depreciation rate for the class of asset.
Since the introduction of the $150,000 Instant Asset Write Off, businesses can now write off the cost of the asset (providing it is $30,000 or under) in the same financial year as they bought it instead of the ongoing depreciation rules that previously applied (and still do apply to assets that cost greater than $150,000).
What Type Of Purchases Should I Consider Making?
Before making any large purchases, we suggest you speak to your accountant or tax professional and assess how the asset will benefit your business and how the purchase may impact on your cash flow or finances in the short term.
If you decide to take advantage of the instant asset write-off, you should make the decision based on the needs of your business. For example, if you need to purchase a vehicle for deliveries to expand your business operations to help you achieve your business goals, or because it is in line with your business plan.
What Happens If I Make A Purchase That Is Greater Than The Write-off Amount?
The instant asset write-off threshold applies to the total cost of the asset, not just its taxable portion. Any purchases equal to or more than the threshold can be put into your small business asset pool, where you will be able to claim gradual deductions (depreciation) each year.
Does Every “Small Business” Qualify?
The write off is only available to small businesses with an aggregated turnover of less than $50,000,000. Further, the entity that is purchasing the asset must be trading business – meaning that the entity conducts business in its own right.
Is Every Business Asset Eligible To Write Off?
No. Whilst most assets are, there are a number of asset classes or types that the ATO has excluded from the scheme. These include capital works assets, horticultural plants (including grapevines) and more. Check with your Accountant or Tax Advisor for more information on your individual circumstances.
Work Out Your Deduction
The entire cost of the asset must be less than the relevant threshold, not including any trade-in amount. Whether the threshold is GST exclusive or inclusive depends on if you’re registered for GST.
To work out the amount you can claim, you must subtract any private use portion. The balance (that is the portion you use to earn assessable income) is generally the taxable purpose portion (business purpose portion). While you can only claim the taxable purpose portion as a deduction, the entire cost of the asset must be less than the relevant threshold.
This also applies to research & development (R&D) use. When you work out the amount you can include in the calculation of your R&D tax offset for your R&D use, you must subtract any non-R&D use including the taxable purpose portion and private use portion.
Later sale or disposal of the asset
If you use the instant asset write-off for an asset and then sell or dispose of that asset, you need to include the taxable purpose portion of the amount you received for the asset in your assessable income for that year.
Suppose you use the instant asset write-off for an asset that is later destroyed (for example, in a bushfire or flood). In that case, the amount you receive (such as from an insurance payout) for the destruction of the asset is included in your assessable income.
What About Trading In An Asset?
When it comes to trading in an asset, there are a few things to remember
Purchases made from March 12 2020
If you’re trading in an asset and the process appears as two transactions – e.g. you purchase a new car for business purposes and sell your existing vehicle. The cost of the new vehicle will need to be below the $150,000 threshold to qualify for the instant tax write-off. This is irrespective of the money made from selling the original asset. So, if your new vehicle is $180,000, but you made $35,000 selling your previous vehicle, even though the transaction cost a total of $145,000, you would still have to add the new purchase to your small business pool.
Purchases made before March 12 2020
The same process applies to the lower threshold. So, if you purchase new equipment before March 11, 2020, and it came to $35,000, but you made $7,000 selling your old equipment – even though you were only $28,000 out of pocket (below the threshold) – you would still have to add the new purchase to your small business pool.