Everyone has done this – you get a large bill and think to yourself, where am I going to find the money to pay this? And with the cost of everything currently going upwards at an alarming velocity, finding sufficient cash when bills are due can be tricky.
Don’t let the ATO cause you angst. Life is too short to be stressed about expenses, especially tax ones.
The TL;DR (Too Long; Didn’t Read) for busy people:
Instead of trying to find a large amount in one go, put aside small amounts often. The goal is that when the large bill arrives, you have already saved up enough to pay it.
This article talks specifically about tax bills, however you can apply similar principals to any large expense.
There are two ways to go about this:
- The, I don’t want to put too much effort into this, method; or
- Science
1. The, I don’t want to put too much effort into this, method
This is also known as trial and error, or educated guessing.
It goes something like this:
- Set up a new bank account in your business’ name, and call it some sort of savings account. Tax Savings, Stress-Reducing Savings, be creative. (As an accountant, I am of course not creative, so I’m quite sure you can do better than me).
It doesn’t need to specifically be a savings account, however you might prefer that it be an account that earns interest. As interest rates continue to rise, you may as well get some benefit out of the situation, however minor that may be. - If you are registered for GST, then each month move 25-30% of your income for the month into that account.
- If you are not registered for GST, then each month move 20-25% of your income for the month into that account.
- This last step is very important – do not use the money in this savings account for anything other than paying the ATO.
If, at the end of the year you find you have money leftover – ie, you have saved too much – then take yourself and a special friend out to a nice dinner and then in the following year reduce the percentage you put aside by a bit (or not, as you choose).
If however you find that you have not saved enough, then in the following year increase the percentage you put aside by a bit.
That is the trial and error part. Repeat this process every year and within a few years you should get to a percentage that more or less covers your tax bills.
2. Science
This method takes a bit more work, but is more accurate without the need for tedious trial and error. It does instead involve potentially tedious mathematics as it requires actual calculations of tax payable. You can, if you like, build in an extra amount for a nice dinner at the end of the year with your special friend.
This method works best (ie is easiest) when your business is run through a company, due to the flat company tax rate. However it can still be done, albeit with more of the aforementioned tedious maths, for sole traders, trusts and partnerships.
It is what I myself do and of course I have a spreadsheet for it. Let me know if you’d like to see a sample of my spreadsheet as I am always up for a good spreadsheet discussion.
For a company, it goes like this:
- In the first week of each month, make sure all of your transactions for the previous month have been entered into your accounting software and categorised correctly (that part is very important), and the bank accounts have all been reconciled.
- Run a Profit and Loss Report, and also an Activity Statement or GST or BAS Report – both year to date.
- Your accountant or bookkeeper will be able to help you with steps (a) and (b) if you are unsure how to go about it.
- Calculate 25% (if your company runs a business) or 30% (for investment companies) of net profit year to date. Ask your accountant if you are unsure which rate to use.
- Use the Activity Statement Report to determine net GST year to date.
- Add the two amounts from steps (d) and (e) together.
- Check the current balance of your savings account.
- Put enough funds into the savings account such that the balance of that account equals (roughly) the amount you calculated at step (f). Round it up to a nice number if you prefer to deal in whole dollars.
You might find that, due to the tedious maths involved in tax calculations for individuals, trusts and partnerships, that the second method is not worth bothering with for those structures. And that’s okay. The first method will do just as well.
However if you would like to attempt it, here is how it can be done:
For a sole trader, the calculation of tax payable at step (d) is not as straightforward, as individuals are taxed on marginal rates not a flat fixed rate as companies are.
Tax rates for individual taxpayers are here. Use these at step (d) instead of 25% / 30%.
https://www.ato.gov.au/rates/individual-income-tax-rates/
For partnerships, at step (d) divide the net profit year to date between the number of partners (or calculate each partners’ share if partners do not get equal shares). Then use the individual tax rates to calculate each partners’ tax payable.
Trusts can be a little (and in some cases a lot) more tricky, because trusts themselves do not generally pay tax and the tax calculation at the individual level depends on how much each beneficiary will receive as distribution. The, err on the side of caution and potentially put too much aside approach, would be to base the tax payable calculation on an assumption of one beneficiary receiving the entire net profit of the trust. Otherwise, your accountant may be able to help determine an estimated distribution for each beneficiary that will suffice for these purposes.
In all three cases, remember to take into account any other income that individual taxpayers may have that will affect their tax payable.
Remember this is all an estimate, it does not have to be 100% accurate. The only consequence to getting the calculations wrong, is that you have too much or not enough money set aside for your tax bills. But you will have at least most of it. Pat yourself on the back, you are now stress free.
Has this helped? Let me know if you have tried either of these methods and how they have (or haven’t) worked for you. And if you have another method that works for you, I’d love to hear about it!
