Tax Offset vs Tax Deduction: The Ultimate Guide

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The recent Federal Budget extensively discussed providing temporary assistance to households through tax offsets. However, there seems to be some confusion among the general public regarding the distinction on tax offset vs tax deduction.

Both can contribute to lowering your annual tax liability, but typically, a tax offset leads to a greater dollar tax saving compared to a tax deduction of equivalent value. The pivotal distinction lies in the stage of income calculation at which they are applied, influencing the final amount of tax owed.

What is a tax deduction?

A tax deduction stands as a primary adjustment made to your income during the computation of your tax liability. This deduction serves to decrease your taxable income, consequently reducing the amount of tax you are required to pay. In some cases, it might even shift you into a lower tax bracket. The purpose of deductions is to ensure that you are only taxed on income that surpasses the expenditures associated with generating that income.

In the context of a small business, deductions play a crucial role in preventing taxation if the operational costs exceed the generated revenue. Common deductions for a small business encompass operating expenses like stationery and capital expenses such as equipment.

Furthermore, there exist temporary deductions, exemplified by the additional 20% deduction introduced in the 2022 Federal Budget. This deduction applies to expenses linked to digital adoption, encompassing items such as portable payment services and cybersecurity, as well as employee training expenditures.

Individual employees can also capitalize on deductions in a parallel fashion. Personal deductions encompass work-related expenses, such as the purchase of a computer for a home office, or supplies acquired for classroom use by educators. Other deductible expenses for individuals include the management of tax affairs, charitable donations, and the cost of income protection insurance.

What is a tax offset?

In contrast, tax offsets are subtracted at the conclusion of the calculation process, directly diminishing the amount of tax you are required to pay.

Governments employ offsets to incentivize particular outcomes, such as fostering the adoption of health insurance through the Private Health Offset or contributing funds to your spouse's superannuation via a contribution offset. Additionally, offsets are utilized to offer tax relief or financial assistance to specific groups within the community.

Calculating tax | tax offset vs tax deduction

To grasp the distinction between an offset and a deduction, let's delve into an example.

In the scenario outlined in the table below, there are two taxpayers. One individual earns $30,000 annually, subject to a tax rate of 19 cents for every dollar exceeding the tax-free threshold of $18,200. This results in a tax liability of $2,242 before factoring in any deductions or offsets. The other taxpayer earns $130,000 per year, incurring the top marginal tax rate of 37 cents for every dollar beyond $120,000, resulting in a tax obligation of $33,167.

Observing the table, it becomes apparent that a $1,000 tax deduction has a more substantial impact on tax savings for the higher income earner, yielding $370 in contrast to $190 for the lower income earner.

However, a $1,000 tax offset not only delivers a larger tax saving of $1,000 for both taxpayers but holds a relatively greater value for the lower income earner, constituting 3.3 percent of $30,000 compared to less than one percent of $130,000.

Impact of a $1,000 tax deduction and tax offset on tax owed

Assessable incomeTax Owed$1,000 tax deduction$1,000 tax offset
Tax owedTax savedTax owedTax saved
$130,000$33,167$32,797$370$32,167$1,000
$30,000$2,242$2,052$190$1,242$1,000
Source (with updated figures for 2021-2022 financial year): ANU Tax and Transfer Policy Institute Tax Fact #6

How tax offsets affect the tax you pay

In contrast to tax deductions, most tax offsets are automatically applied by the ATO when you submit your tax return.

While tax offsets can reduce your tax payable to zero, they cannot generate a tax refund if you have no tax liability. If your taxable income is $18,200 or less, an offset won't decrease the tax you pay since your tax payable is already zero. In this case, if you've paid any tax on this amount, it will be refunded, but no offset is utilized.

It's important to note that most tax offsets do not affect the Medicare Levy and Medicare Levy Surcharge (if applicable) that you are obligated to pay.

The amount of tax offset you receive is also contingent on the specific offset and your taxable income. For instance, with the Low and Middle Income Tax Offset (LMITO) for the 2021-22 fiscal year, if your taxable income is $37,000 or less, you qualify for a $675 offset on your tax payable upon filing your tax return. However, if your income falls within the range of $48,001 to $90,000, the offset increases to $1,500.

The importance of seeking professional tax advice becomes evident, especially considering the nuanced distinction between tax offset and tax deduction is merely the starting point. Tax affairs tend to be intricate and opaque, and this complexity is likely to intensify over time. Trusted advice serves as a valuable resource that will only become increasingly significant for your enterprise. It's essential to recognize that this article provides an overview for informational purposes only. For personalized guidance, consulting with your professional tax advisor is recommended. Feel free to contact us to address your queries, explore options, and formulate strategies for both taxation and a comprehensive range of forward-looking business matters.

Acro Accounting & Financial Planning (AAFP) offers a one stop solution right from accounting, taxation, financial planning to other business advisory services. As Certified Practicing Accountants (CPA’s) and professional tax advisors, we pride ourselves on being experts with the latest developments relating to business and taxation. We as professional public practice firm, provide high quality taxation and business advice to our clients through a personalised service at competitive rates.

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