Business Basics, Tax & Accounting

The Low Down on Losses

Most new businesses take some time to become profitable, particularly when they have expanded from a hobby basis.  Often at this stage the business owner is working a regular job, and growing their business in their spare time, so how does beginning a hobby business affect your tax?

It’s often thought that the loss from a hobby business, operated as a sole trader or partnership, can be used to reduce your taxable income and therefore the tax payable on your earnings, however there are some special rules before you can do this.  These rules are called “non-commercial loss” rules, and there are two stages to the rules.

Stage 1

You must pass the income requirement before you are able to offset business losses against your other income.

This requires that your other income be less than $250,000

Other income includes:

  • Taxable income (ignoring any business losses)
  • Total reportable fringe benefits amount
  • Reportable superannuation contributions
  • Total net investment loss

If you pass the income requirement you then need to meet one of the four tests in Stage 2

Stage 2

You must pass one of the following four tests:

  • Assessable Income test:  your business has assessable income (revenue) of at least $20,000.  If you were in business for less than a year you can make a reasonable estimate of what a full year’s income would have been.
  • Profits Test: your business had a profit for tax purposes for three out of the past five years (including the current year)
  • Real Property test: the value of real property or an interest in real property used in your business on a continuing basis is at least $500,000
  • Other assets test: the value of assets (excluding real property, cars, motor cycles and similar vehicles) you used on a continuing basis in carrying on your business is at least $100,000

If you pass both stages then you can reduce your other income by your business loss.

I don’t pass the tests – now what?

If you don’t pass the tests, the loss is carried forward indefinitely until either of the following occurs

  1. Your business makes a profit – you can then reduce the profit by the losses carried forward (deferred)
  2. You pass the two stages already mentioned – then the deferred loss from prior years (as well as any loss incurred in the year you satisfy the tests) can be used to reduce your other income.

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