Sole Trader Tax Deductions: What You Can and Cannot Claim

Almost every deduction question a sole trader asks comes back to one general principle: an expense is deductible to the extent it is incurred in earning your assessable income, is not private or domestic in nature, and can be substantiated. If an expense fails any one of those three tests, the deduction is reduced or denied — no matter how genuinely the money was spent.

The first limb is the connection to income. There needs to be a real link between the expense and the income your business earns. Buying tools you use on jobs, paying for software that runs your business, advertising your services — these have a clear nexus to assessable income. Expenses with no genuine connection to producing income generally are not deductible, even if you paid them from the business account.

The second limb is the private-or-domestic exclusion. Many sole-trader costs are mixed — part business, part private. A phone, a car, electricity at home. Where an expense serves both purposes, only the business portion is generally deductible, and you need a reasonable basis for working out that portion. The third limb is substantiation: you generally need written evidence, and you need to keep it. Throughout this guide, references to deductibility are general in nature; whether a specific expense is deductible always depends on your circumstances and the rules that apply for the relevant year.

Once the basic rule is understood, most sole-trader expenses fall into a handful of recurring categories. The following are commonly deductible where they relate to earning your assessable income and are properly substantiated — but the deductible amount, and any apportionment for private use, depends on your circumstances.

• Tools and equipment — items used in the business. Lower-cost items may generally be claimed outright, while higher-cost assets are typically written off over time through depreciation, subject to the rules in force for the year.
• Software and subscriptions — accounting software, design tools, industry subscriptions and other recurring business services.
• Phone and internet — the work-related portion only, supported by a reasonable apportionment based on actual business use.
• Insurance — business-related cover such as public liability or professional indemnity; income-protection treatment differs and depends on the policy.
• Accounting and tax-agent fees — the cost of managing your tax affairs, including return preparation and tax advice.
• Stationery, materials and consumables — items genuinely consumed in running the business.
• Advertising and marketing — promoting your services to generate income.
• Bank and merchant fees on business accounts and payment facilities.

Two practical notes apply across all of these. First, keep business and private spending separate wherever possible — a dedicated business account makes apportionment and substantiation far simpler at year end. Second, where an item is part-business and part-private, claim only the business portion and keep the working that shows how you arrived at it.

Many sole traders run all or part of their business from home, which raises the question of how to claim the additional running costs that working from home creates — the extra electricity and gas, phone and internet, and the decline in value of office furniture and equipment. As a general matter there are two broad approaches to claiming these running expenses, and you choose the one that fits your records and produces a sensible result.

The first is a fixed-rate method, under which you claim a set cents-per-hour fixed rate for each hour you work from home. That single rate is intended to cover a defined bundle of running costs, and the rate itself is set and updated by the ATO from time to time. The attraction of this method is its simplicity: you keep a record of the hours worked from home and apply the rate, rather than calculating each underlying cost.

The second is an actual-cost method, under which you work out the genuine additional running expenses you incurred because you worked from home, apportioned for any private use. This method can produce a larger deduction where your home running costs are high, but it carries a heavier record-keeping burden — you generally need to substantiate each cost and the basis for apportioning it. Whether the fixed-rate or actual-cost approach is better, and what records each requires, depends on your circumstances. Occupancy expenses such as rent, mortgage interest and rates sit in a separate category and only become relevant in limited situations, which can carry other consequences worth discussing before you claim them.

Car expenses are one of the most common — and most commonly overstated — sole-trader claims, so the rules deserve care. The general position is that you can claim the business-use portion of car costs, and there are two broad methods for doing so. The private portion of any travel, including normal home-to-work travel, generally is not deductible.

The cents-per-kilometre method applies a set per-kilometre rate, updated annually by the ATO, to your work-related kilometres, up to an annual cap on business kilometres. It is the simpler method: you do not keep a logbook, but you do need to be able to show how you calculated your business kilometres. The single rate is designed to cover all running costs, so you do not separately claim fuel, servicing or decline in value on top of it.

The logbook method instead works out the business-use percentage of the car from a representative logbook period and applies that percentage to your actual running costs, including fuel, servicing, registration, insurance and decline in value. It can produce a larger deduction for higher-business-use vehicles, but requires a valid logbook and supporting records. Which method gives the better outcome depends on your circumstances — your business-use percentage, your total running costs and the kilometres you travel — so it is worth comparing both before lodging.

Just as important as knowing what to claim is knowing what to leave out. Including non-deductible amounts is one of the most common reasons a sole trader’s return attracts ATO attention, so the following items generally should not be claimed — or should be claimed only to the limited extent the rules allow.

• Private and domestic expenses — anything genuinely for personal living rather than earning income, including the private portion of mixed-use items.
• The private portion of mixed expenses — the personal share of a phone, car, internet connection or home running cost is not deductible, even when the business share is.
• Entertainment — most entertainment costs, such as social functions and many client meals, generally are not deductible.
• Fines and penalties — fines imposed under a law, such as parking and speeding fines, generally are not deductible.
• Expenses with no income-earning connection — costs that fail the basic nexus test, however genuinely incurred.
• Amounts that are capital in nature — these are generally not claimed outright; they may instead be recognised over time, where the rules permit.

Where an expense sits on the line — for example, a cost that is partly capital and partly revenue, or partly business and partly private — the safer course is to identify and exclude the non-deductible portion and document your reasoning, rather than claim the whole amount and hope it holds up. Whether a particular item is deductible always depends on your circumstances and the relevant rules.

Good records are what turn a reasonable deduction into a defensible one. As a general matter, you need written evidence to support the deductions you claim, and you need to keep that evidence for a set period — generally five years from when you lodge the relevant return, although longer periods can apply in some situations such as where an asset is involved in a later capital gains calculation.

The practical record set for a sole trader generally includes: receipts, tax invoices and bank records for business expenses; a valid logbook and odometer records if you use the logbook method for the car; a record of hours worked from home if you use a fixed-rate home-office method; and the apportionment workings that show how you split any mixed-use expense between business and private use. Where you claim the work-related portion of a phone, internet connection or vehicle, the working that supports your percentage is part of the evidence.

Keeping these records as you go — rather than reconstructing them at year end — makes lodgement faster, reduces the risk of overstating or understating a claim, and puts you in a far stronger position if the ATO ever asks how a figure was worked out. This guide is general information only and does not take into account your objectives, financial situation or needs; it is not personal tax advice. Your circumstances differ, and the rules change between years. For advice on your own situation, our practice prepares sole-trader returns for a fixed fee, scoped to your situation and quoted in writing, so you know what is included before any work begins.