Income and expenses are the basis of everything for entrepreneurs – not only for cash flow management, but especially for income tax calculation. And therein lies the rub: not everything you actually pay is a tax expense, and not all the money you receive enters the tax base.
Below we will look at how income and expenses work from a tax perspective, what exactly tax and non-tax income and expenses mean, how to keep proper tax records of income and expenses and what typical mistakes lead to entrepreneurs paying too much in taxes or causing unnecessary problems with the tax office.
Before you get into the actual tax calculation, it’s a good idea to be clear on a few basic concepts:
Income is any amount of money you receive as part of your business – either in a bank account or in cash. For example, it could be a payment from a customer for a service or goods, payment of an invoice, or reimbursement from an insurance company related to the business.
However, not all money received is automatically “taxable income” – some is not included in the tax base (typically loans, business deposits, etc.). Therefore, in practice, a distinction is made between tax and non-tax income.
An expense, on the other hand, is any payment that leaves the business – from the account or from the cash register. This includes, for example, the purchase of materials, goods or services, office rent, payments for telephone, internet or employee remuneration, payments to accountants, lawyers, etc.
But even here, it’s not true that everything you pay automatically reduces your tax. Only expenses that are related to the business and meet the conditions of the law are tax deductible. The rest are non-tax expenses – you see them in your records, but they are not taken into account for tax purposes.
Not sure how to do your taxes correctly so you don’t get it wrong? We can help you navigate the law, whether it’s dealing with a specific tax situation, preparing for an audit by the tax authority or defending yourself in court.
If you subtract the total income from the total expenses, you get the profit or loss. This profit gives you a basic idea of whether and how profitable the business is. But for income tax purposes, it is usually not yet the final figure – it needs to be ‘adjusted’ for certain items.
The tax base is, in simple terms, the ‘adjusted profit’ on which income tax itself is calculated. It is therefore not based on the difference between income and expenditure alone, but this difference is further adjusted. First, non-tax expenses are excluded, i.e. expenses that you have actually paid but which cannot be considered tax deductible under the law (typically, for example, entertainment expenses or various fines). Next, non-taxable income is taken into account – that is, income that is not subject to tax or is exempt from tax and therefore does not enter the tax base. Finally, other adjustments are added to or subtracted from the result, most commonly tax depreciation of assets, the creation and use of legal reserves and similar items.
Businesses in the Czech Republic basically have two main ways of keeping their finances for tax purposes – tax records of income and expenses or accounting. Each of these approaches has different administrative requirements and levels of detail, but also different advantages in terms of business overview. In the following section, we briefly review both approaches so that you can better decide which one is better for you.
Tax accounting is primarily for individuals(self-employed) who are not an accounting entity. It is typically used by smaller entrepreneurs with simpler businesses, lower turnover and no complex transactions. The purpose of tax records is mainly to correctly calculate the income tax base, but nothing more – no balance sheet, profit and loss account or other accounting statements are processed.
You can typically keep tax records if you are self-employed, not registered in the Commercial Register and your turnover for the previous year did not exceed CZK 25 million. ( if you exceed this limit, you become an accounting entity and must start keeping accounts).
It is worthwhile if you have a relatively small or medium-sized business, a limited number of invoices, a simple cost structure and do not need detailed reporting for banks or investors. The administration is simpler, cheaper and you can often do it yourself.
This article focuses on the situation where you claim actual expenses and keep tax records. However, for self-employed people there is also the option of using flat-rate expenses (expenses as a percentage of income):
In the case of flat-rate expenses, you do not report individual tax and non-tax expenses in detail – the amount of expenses is set as a percentage of income. However, you can only claim lump-sum expenses up to a certain limit; once you exceed this limit, the option ceases. This makes administration simpler, but on the other hand, the resulting tax may be higher if your actual costs are actually higher than average.
Even if you don’t deal with individual tax-deductible expenses in a lump sum, it’s good to understand the principle of tax and non-tax income and expenses. This will help you assess whether a flat rate is actually a good option for you or whether it would be more worthwhile to claim actual expenses.
In addition, you can also opt for a flat-rate tax if you meet the conditions. Find out how this option works.
Accounting is a more complex system that tracks all of a company’s economic operations: assets, liabilities, expenses, revenues, accruals, receivables, inventory, etc. Its aim is not just to determine tax, but to give a true and fair view of a company’s operations.
Accounting is compulsory for legal entities (e.g. Ltd., Inc.) and for natural persons who become an accounting entity – typically when their turnover for the previous year exceeds EUR 25 million. CZK, or they are registered in the Commercial Register, or they are obliged to do so by a special legal regulation.
You may voluntarily settle your accounts before it is compulsory if:
On the other hand, it is a more knowledge- and time-intensive system, so most entrepreneurs leave its management to a professional accountant or a specialized accounting firm.
In terms of income tax, income is divided into taxable (taxable) and non-taxable (non-taxable):
Taxable income includes, but is not limited to, receipts from the sale of goods, products and services, income from the provision of miscellaneous services, interest earned on a business account, reimbursements from an insurance company related to the business, income from the sale of property classified as business property, and also advances received, if you consider them as income in your tax records. This income enters the tax base and is the basis for calculating income tax.
By contrast, non-taxable income is income that is not subject to tax, is exempt from tax or, by its nature, does not affect the result of the business. Typically, these are contributions by the entrepreneur of his personal funds to the business, loans and borrowings received, certain types of subsidies (for example, investment grants , which are treated differently from ordinary operating income), refunds of excessive VAT deductions or other legally exempt income.
These items are good to keep in the records (for an overview of assets and liabilities), but they do not form part of the income tax base.
It depends on which mode you use. If you keep tax records, you follow the “paid = taxed” principle. This means that it is the moment when the money actually arrives in your account or cash register that is decisive. Accounting, on the other hand, is based on the accrual principle – income is recorded as revenue at the time of the transaction (delivery of goods, provision of services), even if it has not yet been paid. The calculation of the tax base is then based on this.
Not to the full extent, but even with flat-rate expenses you must keep at least a record of income and receivables to be able to document the state of the business and correctly fill in tax returns and reports for the Social Security and Health Insurance Institutions.
Simply put: add up all your real tax-deductible expenses (including depreciation of assets) and compare them to the amount you would have received as a lump sum (a percentage of income depending on the type of activity – 80%, 60%, 40%, 30%). If your real costs are higher than the lump sum in the long run, your real expenses will pay off. You can read more about the benefits of flat expenses for self-employed people in our article.
The transition is associated with adjustments to the tax base – particularly for inventories, receivables, payables and assets. The Income Tax Act sets out how to take these items into account to avoid double taxation or, on the contrary, the loss of part of income or expenses. In practice, this means taking stock on the last day of the “old” regime and including adjustments in your tax return. These transitions are difficult to make without professional help, so it pays to involve an accountant or tax adviser.
The basic rule for recognising expenses for income tax purposes is that tax expenses are those incurred to earn, secure and maintain taxable income. In other words, the expense must have a genuine connection to your business and you must be able to substantiate that connection, typically with an invoice, contract, purchase order or other relevant document.
Tax-deductible business expenses include, for example, the purchase of goods, materials and raw materials (for example, materials for a specific order), employee salaries including compulsory contributions,social security and health insurance payments for employees and the self-employed person, rent for an office, premises or warehouse, as well as expenses for energy and services – electricity, water, internet or telephone. It also includes travel allowances, accommodation and transport on business trips, remuneration and payments to service providers such as accountants, lawyers, marketing agencies or IT specialists.
Fixed assets (for example, a car, a machine or more expensive equipment) are not expensed in full at one time, but through tax depreciation spread over several years. Mandatory business-related insurance policies, such as liability insurance, may also be tax deductible.
Some items are often used both for business and private use (e.g. a car, mobile phone, internet or home office). In such cases, only the proportion of the expenditure corresponding to the actual business use is therefore claimed. The business should be able to reasonably justify this proportion and, if necessary, provide evidence – for example, a log book for a car or an estimate of the proportion of business calls and private use for a telephone.
Do you use your company car for private purposes? Learn how to get it right on your taxes.
Non-tax expenses (non-allowable expenses) are expenses that you actually pay but cannot claim for the purpose of reducing your taxable amount. The Income Tax Act lists them, and it does so in the form of a demonstrative list, i.e. a list of typical examples, not all possibilities.
Among the most typical possibilities we can mention, for example, the costs of acquisition of tangible and intangible assets, such as the purchase price of a car, a machine or office equipment – these amounts are not applied in one lump sum, but gradually through tax depreciation.
This also includes entertainment expenses (typically refreshments at meetings, coffee or dinner with a client, more expensive gifts or luxury treats). Non-tax expenses also include fines, penalties and sanctions imposed by government authorities, equity-related expenses (for example, the cost of increasing the share capital of a limited liability company). Certain financial costs, such as a certain amount of interest, may also fall under this category.
These expenses are normally included with other expenses in your tax records, but you must exclude them from your tax base when calculating your tax, so they have no direct effect on your resulting tax liability.
Mr Novak is a freelance graphic designer. During the year, various payments come into his account and into his cash register, and money goes out of them in the same way. At first glance, everything looks like simple income and expenditure, but from a tax perspective each amount behaves differently.
In January he issues an invoice for web design for 40,000 CZK. The client pays it into his account. This is typical tax income – a direct result of his business that enters the tax base.
In February he designs a logo for another company, the invoice is for CZK 15,000 and the client pays in cash. From a tax point of view, it’s exactly the same situation: income from a business that counts towards the tax base because of income tax.
During the year, Mr. Novák then carries out other orders (graphic design, web design, banners, etc.). In total, he receives CZK 500,000 from clients throughout the year – that is all his business tax income.
Not sure how to do your taxes correctly so you don’t get it wrong? We can help you navigate the law, whether it’s dealing with a specific tax situation, preparing for an audit by the tax authority or defending yourself in court.
In March, Mr Novák will take out a business loan of £200,000 for new studio equipment. Although a large amount appears in his account, it is not income, but a debt – a liability to the bank. From a tax perspective, this is not taxable income and will not be included in the tax base.
In April, he then sends CZK 50 000 from his personal account to his business account as his own deposit in order to have a reserve for operations. Again, this is an inflow of money into the business, but again it is not a profit. It is just a boost to his own resources and therefore non-tax income.
In a year, Mr Novák receives CZK 250,000 in non-tax income (loan + own deposits), which does not enter the tax base.
In January, Mr Novák buys graphic software for CZK 12 000 and pays a printer CZK 8 000 to print flyers for a client. Both payments are directly related to his orders and are therefore tax deductible expenses.
Each month he pays CZK 10 000 for office rent and approximately CZK 3 000 for electricity and internet. For the whole year he pays CZK 120,000 for rent and CZK 36,000 for energy and internet. Without an office or energy he would have no place to work, so these amounts are also tax deductible operating expenses.
In May, Mr Novák invites an important client to lunch at a restaurant where they discuss a new project. The expense of CZK 1 500 is paid by business card. From a tax point of view, this is a representation, i.e. a non-tax expense. Although it appears in the records, it is excluded from the result when calculating the tax base.
In June, Mr Novák will be fined CZK 2 000 by the tax office. He pays it from his company account, so it is a real business expense. However, fines and penalties imposed by the authorities are legally classified as non-tax expenses. This means that he cannot use them to reduce his tax liability, even if they have actually taken money out of his pocket.
He also accidentally pays a purely private purchase of CZK 5,000 from his business account during the year. From an accounting/recording point of view, this is still an expense from the account, but tax-wise it is a private consumption which will not affect the tax base.
In July, Mr Novák buys a new powerful computer and a large monitor for a total of CZK 120 000. He pays the amount in one lump sum from his business account.
As the purchase price of the computer is higher than the statutory limit for tangible fixed assets and he will use the computer for more than one year, he classifies it as tangible fixed assets (computer equipment in depreciation group 1).
In the first year, Mr Novák calculates the tax depreciation of CZK 24 000 according to the statutory rates. This CZK 24 000 is already a tax deductible expense which reduces the tax base. He will claim the rest of the purchase price as depreciation in subsequent years.
So:
At the end of the year, Mr. Novak sits down at the tax records and tries to put the whole year into numbers. For example, he finds that:
For the calculation of the tax base, he is only interested in the CZK 500 000 of tax income.
On the expenditure side, he sees a total of CZK 328 500. When he divides it up, he finds that of this:
For tax purposes, he is only interested in the difference between tax revenue and tax deductible expenses. This means that he puts CZK 200,000 of tax expenses against CZK 500,000 of income and ends up with a tax base of CZK 300,000. Income tax is then calculated on this amount.
Income and expenses are not the same for the tax office as they are for your bank account. A distinction is made between tax and non-tax income and expenditure – only tax income and expenditure goes into the tax base. Taxable income is typically sales of goods and services, interest on a business account, or reimbursements from an insurance company related to the business. On the other hand, loans, borrowings, own deposits or certain grants are non-tax income – you see them on your records but don’t pay tax on them. As for expenses, the basic rule is that to be tax deductible, the expense must be demonstrably related to the production, provision or maintenance of taxable income and you must be able to substantiate it. Representations, fines, one-off property acquisitions or purely private payments are non-taxable expenses and will not reduce your tax base.
How you manage your finances is then key to calculating income tax. Smaller self-employed people usually use tax records of income and expenditure and claim either actual expenses or a flat rate as a percentage of income. Larger and more complex businesses already fall under double-entry bookkeeping, which tracks all of the company’s assets, liabilities, and income statement, and is used not only for tax purposes, but also for banks and investors. Mr. Novak’s example shows that the same “inflows and outflows” of money behave differently from a tax perspective: a loan or an equity deposit is not a profit, the purchase of a computer is reflected in taxes gradually through depreciation, and lunches with clients or fines, while they will worsen cash flow, do not reduce the tax base. Those who understand these differences and are able to distinguish them correctly in their records usually pay less in taxes and avoid unnecessary disputes with the tax authorities.
It depends on the type of subsidy. Operating subsidies (e.g. for wages, rent or operations) are taxable income and enter the tax base. Conversely, some investment subsidies may be treated differently and are reflected gradually through depreciation or asset adjustments.
Clothing is a taxable expense only if it is clearly intended for the performance of a job(work clothes, uniform, protective equipment, clothing with a company logo, etc.). Ordinary business attire, even if worn for meetings with clients, is considered personal consumption and is not a tax deductible expense.
Fixed assets (e.g. cars, machinery, more expensive equipment) are reflected in tax expenses gradually through tax depreciation. The law specifies depreciation brackets and minimum depreciation periods; you choose straight-line or accelerated depreciation and apply the appropriate portion of the purchase price each year.
Not sure how to do your taxes correctly so you don’t get it wrong? We can help you navigate the law, whether it’s dealing with a specific tax situation, preparing for an audit by the tax authority or defending yourself in court.
Ondřej is the attorney who came up with the idea of providing legal services online. He's been earning his living through legal services for more than 10 years. He especially likes to help clients who may have given up hope in solving their legal issues at work, for example with real estate transfers or copyright licenses.
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