When a small business starts, they usually earn too little to pay tax. Then as the business grows, more taxes are added, at increasing rates. The faster the growth of the business, the faster the tax bills grow, and it can be a demoralising shock. This post outlines a few tax thresholds to mentally prepare yourself for, so that you don’t abandon your growth plans.
Marginal Tax Rates
Income tax for individuals runs under a system of marginal rates. There are multiple tiers of rates, each a large increase on the last. For the 2014-15 tax year, here are the tax rates for residents: 0%, 19%, 32.5%, 37% and 45%.
As income increases, it may feel like tax is a larger and larger proportion. Some fast-growing clients of mine have been unpleasantly surprised when their first year is in the 0% bracket, but they have leapt to the 37% or 45% bracket in their second year.
After your first year of showing a profit and paying tax, the tax office will usually register you for Pay As You Go Instalments. This means that you need to pay quarterly, or sometimes annual, estimates of your next tax bill in advance.
The first year that this happens, you will have to pay last year’s tax bill PLUS your first year of income tax instalments. An unpleasant effect on your cash flow.
After the first year, this becomes less of a problem, but that first year is painful.
You need to register for GST once you have earned more than $75,000 in the past 12 months, or you expect that you will earn more than that in the next 12 months.
Once you register for GST, 1/11th of your gross revenue must be sent to the tax office, less 1/11th of many expenses. Even if your business is not very profitable.
Some businesses register for GST when they start, in order to effectively get a discount on their expenses. This registration becomes painful once they are paying more GST to the tax office than they get back.
Prepare to Feel Ripped Off
You’re not alone if you feel unhappy.
A number of my clients have businesses that are growing steadily, which means that they have hit these thresholds one after another. Understandably, they weren’t happy!
Don’t Let It Stop You
The purpose of this post is not to scare you away from growing your business. It is a friendly warning, intended to prepare you so that you can maintain your focus on growth, rather than be demoralised into keeping your business small enough to stay under the thresholds.
After you grow beyond the above thresholds, you will still pay tax, but the tax rates stop increasing so fast. There are also more opportunities to (legally!) optimise your tax position, and these can pay for themselves in tax savings every year.
Don’t give up on growth! Just be prepared for a few obstacles along the way.