By Jason Skinner
One of the biggest frustrations in small business is receiving a large, unexpected tax bill out of the blue.
The scenario – You’ve been working hard all year, you think you’re finally getting ahead — and the accountant sends through a tax bill you can’t jump over, and it’s due almost immediately.
It’s not just the size of the bill; it’s usually the timing as well. A bill like this hits your cash flow straight on, right when you thought you were getting ahead, and it can set you back for months.
I regularly sit down with business owners who’ve experienced this very situation. And their reaction is always the same: “Why didn’t I see this coming?” Or “I didn’t make that much money for such a large bill”
Here’s the honest answer: the current tax system is set up in a way that makes it very easy not to see tax bills coming, unless you know how the system works and how to make it work to your advantage.
So, How Does This All Happen?
The financial year ends on the 30th of June each year. However, if you’re using a tax agent, you may not need to lodge and pay tax on that income until the 15th of May of the following year — nearly eleven months later. In that eleven-month gap, the ATO isn’t just waiting patiently for you to sort out your tax affairs. They expect you to pay tax as you go through the PAYG (Pay As You Go) Instalment system for the next year as well. It can often feel like you’re paying two years of tax at once.
The problem is how your PAYG instalments are usually calculated. By default, the ATO bases your PAYG instalments on your most current tax bill that they know about, usually divided into quarterly instalments. This is fine if your income is steady and predictable. But most small businesses (particularly farming) aren’t steady and predictable — you might have a strong year followed by a quieter one, or the reverse. If this year’s income is higher than last year’s, your instalments could be underpaying the prepayment of your tax along the way, and the gap turns up as a lump sum bill once you finally lodge and reconcile everything up down the track. So, the circle of surprises and frustration continues. It can really feel like a vicious hamster wheel.
So, How Do You Fix This?
Three things you can do right now to stop the surprise tax bills.
1. Keep accurate records of your income throughout the year, not just at tax time, when you send your books to the accountant. This will put you more in control and confident about your tax position.
‘If you can measure it, you can manage it.’
A good bookkeeper looking at your books regularly means you should always know where you stand with your profit and loss, your cash flow and most importantly, your tax position.
2. Talk to your Accountant or Bookkeeper about switching to the PAYG percentage method for calculating your quarterly PAYG Tax instalments. This choice can only be made once per year in the September Quarter, which is fast approaching. The percentage method of calculating your PAYG Tax Instalments uses your actual earnings for the quarter to calculate your PAYG Instalments. This ensures the tax being paid is in alignment with the income it relates to for the quarter.
This method and strategy, when implemented and managed correctly, can eliminate your surprise tax bills.
3. Conduct a proper tax planning review session with your Bookkeeper and Accountant before the 30th of June each year. This is your last chance to act on anything before the financial year locks in your tax position — structuring, deductions, timing of income and expenses, super contributions, etc., can all make a drastic difference to your final tax bill.
A tax planning review is also where you find out, well ahead of time, whether you’ll owe anything extra when your tax returns are lodged.
If you’ve been using the percentage method (mentioned above) correctly to calculate your PAYG instalments, there really should be nothing more to pay, or even better, a tax refund could be heading your way.
The Bottom Line
Surprise tax bills aren’t really about bad luck or a broken tax system. The solution could be a simple matter of implementing one of the strategies mentioned above.
If you’re not sure which PAYG Instalment method you’re currently using in your business, or you’ve had one too many of these surprise tax bills, it’s worth talking to your Bookkeeper or Accountant to check this for you. It’s a five-minute conversation that could save you from a very uncomfortable one in the future.
Importantly
The information in this article is general in nature and does not constitute financial or tax advice. Please seek professional advice tailored to your circumstances.
Jason is a CPA Accountant and the principal of Milk Bookkeeping and Advisory, located locally in the Bellingen Shire, and can be contacted at jason@milkbookkeeping.com.au.