Tax benefits of starting a business

Kia ora tatou. Sorry I’m a bit late on this post. It’s been a busy week. Recently we’ve been thinking about what would happen if we were to start a business – particularly in relation to the impact it would have on our taxes. Please note I’m not a tax expert. As always, go get your own advice from a professional. But hopefully what I have to say will be helpful.

Specifically, we’re thinking about operating a business from home. According to IRD rules, this means a portion of our mortgage interest, council rates and utility bills would become a business expense and therefore tax-deductible. Sounds good, right! But how good is it really?

Our mortgage payments are quite low. We pay more than we have to and will pay off our mortgage faster than our bank would like, but because we bought our home before prices took off, we simply have much less mortgage to pay. And obviously with a fixed-rate mortgage, each payment consists of less interest and more principal than the previous payment. So over time, the tax-deductible part of the mortgage payment becomes less.

Furthermore, we can only claim for the portion of mortgage interest for the part of our home we use for the business, e.g. a home office. This is based on what portion of the square-meterage of all buildings on the property is used for business. Given that the majority of what people pay for houses in NZ these days is for the land, only using the area of buildings for this calculation is quite generous on the IRD’s part. If it were the proportion of the overall land, people would be able to claim much less but it would probably be fairer and more accurate in terms of actual business use for mortgage buck, if that makes sense.

All up, we figure we would be able to claim about $350 of mortgage interest as being tax-deductible. I won’t bore you by breaking all the rest down, but basically taking into account rates, utilities and some depreciation on assets we would purchase for business use, in the first year we would be able to claim about $1750 of business expenses.

Not bad. But – and this is the part where people always get confused – $1750 is not how much our tax bill would reduce by. You deduct your business expenses from your overall income and the IRD will tax whatever is left.

For example, if your income from your job plus your business income by some miracle added up to a nice round $100,000, you would owe the IRD $23,920 in taxes. Now, let’s say your business expenses for the year totalled $5000. Deduct that and your left with $18,920 in taxes, right? Wrong! The $5000 is deducted from your income, so you pay tax on $95,000, which is $22,270. Your $5000 in business expenses would save you about $1650 in taxes.

So in our case, our predicted $1750 of business expenses would save us a grand total of about $575 in taxes. Not nothing, but not a huge amount either. The rules in NZ are pretty generous, but unless you’re actually planning to make decent money from your business, it’s probably not worth having one just for tax purposes. Unless maybe you’re paying a lot more mortgage interest than we are!

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2 Comments

  1. A big benefit if you have children going to college is a student allowance. Your business can absorb the income as a cost, basically minimising your income to zero. Your child could get up to $12,000 per year

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