When viewed globally Australia is one of the higher taxing countries. Saying that, we can all breath a collective sigh of relief because Australia is not on the podium for high tax rates. These awards tend to go to European countries who have more socialist economic policies.
We have to remember that taxes build our roads, fund our infrastructure and keep our hospitals operational. You only have to travel a short distance north to the much loved tourist destination of Bali to see how lucky we have it in this country. Of course the big contention is that the Australian Government is not spending the tax dollars wisely and this reminds me of the famous quote from the late Kerry Packer, at the time the richest man in Australia:
This viewpoint has no doubt be around since taxes were invented in Ancient Egypt around 3000–2800 BC.
5 Smart Tax Tips to Maximise Your Tax Return & Pay Less Tax
1. Use Superannuation
Superannuation is the best tax structure available in Australia, with a maximum tax rate of 15%. See the chart below (personal tax rates outlined are excluding medicare levy):
Therefore, where appropriate, you should take advantage of the superannuation environment to build long term wealth. This comes with the proviso that if you are 30 years of age, you will have to wait 30 years until you can access the funds in this structure.
On the other hand if you are 55 years of age, you should be looking to take full advantage of the superannuation environment and investigating the implementation of a transition to retirement strategy.
- Salary sacrificing to the maximum allowable concessional contribution through your employer (talk to HR or your accountant about how to do this)
- After maxing out the above – make additional contributions to superannuation from your own cash.
The key is that superannuation is by far the most tax effective structure for building wealth. Therefore you should be doing everything in your power to maximise the amount of wealth you have in this structure.
2. Limit Your Investments in Your Personal Name
It is quite common to see people making large investments in their personal names. This is rarely a sensible strategy particularly if you are already generating income, such as a salary, from another source. Australia uses a marginal tax rate system, which means the more you earn the more tax you pay.
Of the available structures that can be used for investment, companies will only ever pay a maximum of 30% in tax. If you are a high income earner it will usually be far more tax effective to utilise a trust structure that can advantage of the corporate tax rate. Of course the simplest solution is to invest in your partner’s name if they have a lower tax rate.
3. Invest Tax Effectively
It goes without saying that the easiest way to pay less tax is to invest tax effectively.
What exactly is a tax effective investment?
- Businesses (shares)
Shares are favoured by investors because they generate what is arguably, the most tax effective source of income in Australia, that being fully franked dividends. A fully franked dividend is a distribution from a company that has already paid 30% tax, therefore providing you with a tax credit. If your marginal tax rate if above 30%, you will pay top up tax for the difference. However if your tax rate is 30% or below, you will either pay no additional tax or your will receive a tax refund. Self funded retirees are well aware of the tax benefits of fully franked dividends.
The other big factor is to avoid investments that will realise significant capital gains. If you are actively trading investment assets and make money on assets that have been held for less than 12 months, you will be taxed at your marginal tax rate. However if you are a longer term investor and hold your investments for over 12 months you will receive a 50% capital gains tax discount and this can save you a significant amount of tax in the long run. Warren Buffett became rich by thinking long term, we would suggest you take a leaf from his book and do the same.
Be aware that there are very few investment options in Australia that we would consider tax effective.
4. Use Good Debt Not Bad Debt
The tax system in Australia is geared towards using debt to generate assessable income. What does this mean?
Put simply you get a tax deduction for any costs that are incurred in order to generate an income. The clearest example of this is that the interest costs on a mortgage over an investment property are tax deductible, while the interest costs on your home mortgage are not.
Investment loans (loans used to buy investment assets) are classed as good debt, because they are tax deductible, while loans for personal assets such as homes, cars and personal expenses (credit cards) are not.
5. Start a Business
We just have to look at the annual BRW richlists to know that salary earners will never become amongst the wealthiest members of our society. Why is this?
For example a coffee shop will need employees, a shopfront and a coffee machine before they can even sell one $2 cup of coffee.
Remember small businesses are the engine of our economy, hence we have to support their growth and development.
This doesn’t mean that you need to drop everything and start a new full time business tomorrow. You can do things on the side, start an ebay shop, start buying and renovating properties. These actions will also be considered businesses and will provide some additional tax benefits, such as you being able to claim tax deductions in relation to your ‘business’.
3 Not So Smart Tax Tips to Maximise Your Tax Return
1. Negative Gearing
Negative gearing is most popular amongst property investors. Put simply negative gearing is the process of investing in something that doesn’t pay you enough month to month to cover the costs of holding that investment.
In other words you are losing money, so that you can claim this loss against any other income you have from your salary or other good investments you may have.
Does that make investment sense?
An investment asset is something that puts money in your back pocket.
So why do people negatively gear? They are hoping that in time they will be able to increase rents such that the income will eventually fund the costs of holding the property which are, interest costs on loans, council rates, land taxes, agent fees etc.
In reality most investors will never get their property to become cashflow positive (the direct opposite of negative gearing) and instead they wait for capital growth (i.e. an increase in the value of their property over and above their purchase price) to make their money.
Remember capital growth is uncertain and there are plenty of investors who lose their shirts when their negatively geared properties don’t grow in value.
2. Buying for Tax Deductions
You should never buy something just because it is tax deductible. A tax deduction will only ever give you back the tax that you paid. You do not pay 100% tax on your income, so you will never get 100% of the value of the deduction back.
You will only ever get a deduction for the tax you paid and this is known as your avaergae rate of tax. If your average rate of tax is 30%, that is 30 cents for every dollar you earn. For example if you buy a new computer for $1,000 and this is tax deductible (it depends on your circumstances so check with your accountant), you will only get $300 as a deduction, meaning it still cost you $700 after tax. Not a bad result, but still it wasn’t free money, like many people think.
Calculate Your Average Rate of Tax
To work out exactly how much tax you are paying you want to know your average rate of tax. Your average rate of tax is, as the name suggests, the total tax you pay / your total income. Using this calculation will provide a percentage figure that you can use to complain about how much tax you pay.
Luckily there is a calculator that does just this, from the Money Smart website HERE
There are certain tax deductions that are permitted for most employees in Australia. More information of these deductions can be found on the ATO website here
What tax deductions are you entitled to claim? https://t.co/Wa8teBTzyR
— The Wealth Guy (@TheWealthGuy_) August 11, 2015
We recommend that you familiarise yourself with these deductions and ensure that you and your tax agent are claiming these as part of your tax return. The hardest thing about this is keeping track of your receipts and deductions. For this reason we recommend using a household budget system that can track your spending and record your allowable tax deductions in real time and capture all your relevant data required to complete tax returns at the end of the financial year (we provide this type of facility to our clients).
3. Speculative Investments
If you lose money on a capital investment (like a share or a property) you can deduct this loss against other capital gains you have made during that financial year. If you didn’t make any gains that year, you can carry forward your losses indefinitely until you do have gains. I adhere to Warren Buffett’s number one investment rule: don’t lose money. This should be read in conjunction with his second rule: don’t forget rule number 1.
I hope you enjoyed hacking your tax return with me.
The Wealth Guy