Creating a simple and efficient sole trader tax workflow is the difference between having a stress free tax year that saves you time and money, or being constantly overwhelmed by your taxes. For many sole traders it can also be the difference between business success or failure.
In this final step of our beginners guide to self-employed tax, we’ll explore the the New Zealand sole trader tax process and compare common workflows for managing each step.
So let’s get started streamlining your tax handling, and making it a hassle-free part of your routine.
What is the sole trader tax process?
The New Zealand sole trader tax process consists of four steps:
- Tracking your business income and expenses
- Calculating your current profit and tax
- Putting aside the right amount of tax money
- Filing and paying tax returns
For most sole traders, tax returns are the scariest part of managing their taxes. However, the majority of your time during the year will be spent keeping records and preparing for your tax returns. Good preparation is the key to not only easy and stress free tax returns, but also the financial health and success of your sole trader business.
Let’s explore each step of the process and the common workflows that are available.
1. Tracking income & expenses
Keeping track of your sole trader income and business expenses during the tax year is essential, especially if you’re GST registered. You will need to have your income and expense transactions on hand when it’s time to file your income tax return or GST returns, so it’s best to keep track of these transactions during the year.
Regardless of the workflow you choose I recommend settings up a seperate bank account for your business. It’s not essential and it doesn’t have to be a business account, but having an account that you use specifically for your business will make keeping track of your business transactions much easier.
Common workflows:
- Collect transactions at end of year: Some sole traders put off identifying their income and expenses until their tax return is due. However, it can be very difficult to remember what a transaction was for if it’s been months since you made the purchase. This uncertainty often results in spending more time managing your tax and claiming less expenses.
- Record transactions during year: A common approach is to add business income and expenses to a spreadsheet as they happen during the year. This makes running calculations on your transactions and filing tax returns easier. However, manually processing all your transactions does require consistent habits and time.
- Solo tax app: With Solo you can automatically track your income and claim expenses directly from your bank transactions. Solo provides helpful hints about which expenses you can claim and greatly reduces the time and effort required to track your income and expenses.
2. Calculating current taxes
To complete your GST returns or income tax return you need to calculate the GST portion of your income and expenses, and calculate the claimable portion of each expense (also known as an ‘adjustment’).
For example, you can claim 50% of meal and entertainment expenses relating to your business. If you take a client out for lunch and spent $100, you would need to calculate the GST portion of the transaction ($13.04), then apply 50% to the GST portion ($6.52) and 50% to the GST exclusive portion ($43.48). $6.52 can then be claimed on your GST return and $43.48 on your income tax return.
These calculated figures are essential for filling out your tax returns.
Common workflows:
- Spreadsheet: Recording income and expenses transactions in a spreadsheet, then running calculations on this spreadsheet, is a common method for calculating the figures required for tax returns. This approach is cheap and transparent but can lead to calculation errors. It’s also time consuming and requires you to be familiar with the specific expense rules.
- Online calculator: There are free online GST calculators available which can be helpful for working out the GST portion of a transaction. However these calculators need to be applied to a single transaction at a time. The GST amount of each transaction will still need to be recorded and tallied. There are no free online calculators available for calculating the claimable portion of business expenses.
- Accountant: An accountant will calculate the claimable portion of your transactions when filing your tax returns. The drawback is that accountants typically cost thousands of dollars per year and you will still need to identify and label all of your income and expense transactions.
- Solo tax app: – Solo automatically applies the correct calculations to your income and expense transactions as you go. Claiming expenses and filing tax returns is quick and effortless.
3. Put aside the right amount of tax
Unexpected tax payments can sneak up on you if you’re not prepared and cause a lot of stress. Putting aside money from your income, as you get paid, is essential to not only cover your upcoming taxes but also to understand the financial health of your business. It’s hard to know what you can spend if you don’t know how much sole trader tax you owe.
The challenge with putting tax money aside is knowing how much to put aside, to confidently cover your taxes.
Regardless of the workflow you choose I recommend settings up a seperate bank account just to store your tax money. It’s not essential and it doesn’t have to be a business account, but if you have an account that you use specifically for your taxes you will be less temped to spend your tax money. You will also have a clearer idea of how much money you can actually spend.
Common workflows:
- Not put anything aside: Some sole traders don’t put any tax aside as they get paid and only begin saving for a tax bill when it’s due. Please don’t do this. Having a tax bill due when you don’t have the money is very stressful. And trying to catch up to your tax bills puts a lot of strain on your business. Businesses who choose this approach often don’t survive.
- Put aside a percentage of income: This is the most common approach and involves setting aside a percentage of your income as you get paid (e.g. 30%) and hoping that it covers all your taxes. The drawback is that the amount you put aside is based on an estimate. You never really know if you’ve put enough aside or, allocated money to tax that you could be spending.
- Solo tax app: With Solo you always know exactly how much sole trader tax you owe, and how much you can spend. Solo is the only app that calculates your income tax, GST and ACC live so you always know exactly how much money to set aside during the year.
4. File & pay tax returns
As a sole trader, you are legally required to file tax returns and pay your taxes. These tax returns allow you to report your financial activities to the Inland Revenue Department (IRD), enabling them to determine the right amount of tax you owe. The IRD will then inform you of the tax amount due and offer various payment options.
Regardless of the workflow you choose, following the recommendations mentioned in steps 1, 2 and 3 will make filing your tax returns much easier and less stressful.
Common workflows:
- Do everything when it’s due: Sole traders are busy people and waiting until your tax return is due before preparing your income and expenses (steps 1 and 2) can be tempting. However, this approach is guaranteed to make tax returns stressful and time consuming. You’re also likely to miss out on savings.
- Enter info based on a spreadsheet: If you’re filing an online tax return yourself, keeping a spreadsheet of your income, expenses and any calculations you’ve made is a better approach. This will reduce the time and stress involved in filing your return. However, this could lead to filing your return incorrectly or paying more tax than you need to.
- Accountant: An accountant will file tax returns on your behalf. However an accountant will likely cost thousands of dollars per year. And you will still need to gather your income and expenses (step 1) and put aside your sole trader tax (step 3).
- Solo tax app: With the Solo app you have everything you need to quickly and painlessly file tax returns. Solo automatically generates ready-to-file income tax returns and GST returns. All you need to do is simply copy and paste the figures from Solo into your online tax return. It’s quick, simple and accurate. File tax returns with confidence.
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Mastering the sole trader tax process is about establishing a routine that works for you. By diligently tracking your income and expenses, accurately calculating your taxes, setting aside the right amount of tax money, and efficiently filing and paying your tax returns, you can transform what seems like a daunting task into a manageable part of your business operations. Remember, the key to a stress-free tax experience lies in preparation and the right tools.
With Solo you’re well on your way to not just surviving but thriving as a sole trader. Solo simplifies every step of the sole trader tax process and saves you time, money and stress. Stay organised, stay informed, and watch your business grow!
This is article 6 of 6 in our Self-employed Tax in New Zealand: A Beginner’s Guide.
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