As a small business owner, you know the hard work that goes into building your business to create the lifestyle that you want. Every dollar you save on tax brings you one step closer to achieving your financial goals. Prepaying your business expenses can be an effective tax reduction strategy. In simple terms, it’s spending the money earlier to claim a deduction in the current year.
What is prepayment?
A prepayment refers to an expense that is paid in advance for something that is done in a later financial year. For an expense to be considered a prepayment, it must be incurred for a benefit that is received beyond the current financial year.
Expenses that are completed in the same financial year are not prepayments. Let’s say your business paid for one year of marketing services from 1 January 2018 to 31 December 2018. This qualifies as a prepayment because the service extends beyond 30 June 2018.
How can your business benefit from prepayment?
Businesses with a turnover of less than $10 million can claim an immediate deduction for prepaid expenses of up to 12 months. Making these prepayments means you bring forward your deductions and reduce your tax liability for the current financial year. In addition to this benefit, you may also save on recurring expenses by avoiding price rises over the prepaid period. Some service providers also offer discounts if you purchase in advance.
Be aware that not all prepaid expenses are deductible immediately. If the service period of your prepaid expenses extends beyond 12 months, immediate deduction does not apply. Instead, the deduction will be apportioned in each financial year, until the end of the service period up to a maximum of 10 years. For example, if your lease was prepaid for 5 years, the deduction is spread across the 5 year period because it doesn’t satisfy the 12 month rule.
Some expenses are exempt from the 12 month rule and are immediately deductible. They include:
- Expenses of less than $1000
- Expenses required to be paid by government legislation or court order
- Salary and wages
- Some capital, private or domestic expenses
- Some insurance expenses
Common Prepayment Expenses
Here’s a list of common prepayments you can consider for your small business:
- Loan interest repayments
- Lease/rent payments
- Office supplies
- Vehicle expenses
- Marketing expenses
- Continuing education expenses
If you anticipate a higher income this year than next year, prepayments reduce the assessable income of your business and may make sense. Once you decide to prepay an expense you will not receive a tax deduction in the following year unless you continue to prepay the expense. Keep in mind that prepaying expenses requires you to have cash available. Planning ahead is the key.
Contact Moiler to discuss how you can benefit from prepayments and other tax reduction strategies to maximise your returns.
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