June can be a great month for high-income earners because it is the month you have the opportunity to claw back some of the money you have probably already paid in tax.
And this year, people earning $200,000 a year, classed as emerging high-net-worth by tax adviser BDO Australia, could conceivably cut their taxable income by a handy $121,400 with just four deductions. One of them disappears on July 1.
“I would describe someone earning $200,000 in salary and wages, [as] … emerging high-net-worth,” says Chris Balalovski, a partner at BDO Australia.
“They’re going to start to get exposure to some of the more complex and intricate tax planning opportunities that are just not relevant for routine salary and wage individuals,” he says.
“They should start to really take a greater and deeper interest in their personal taxation affairs and their enterprise taxation affairs because many more things are now going to be becoming relevant.”
How relevant? If the hypothetical taxpayer, who is able to operate as a sole trader, claimed just four deductions, they would get a tax refund of more than $40,000.
And that’s not even including other strategies such as “recycling” nondeductible home loan debt into deductible investment debt and education expense deductions, that high-net-worth investors can use to add thousands of more dollars in deductions, says Ben Nash from Pivot Wealth.
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But before we get to those strategies, if our hypothetical taxpayer did not have their own business – a sole trader in Tax Office language – the above deductions would be limited to $101,400.
A sole trader is someone who runs a business and is personally liable for its debts. For tax purposes, the income of the business is included with any other income of the person and taxed at the person’s marginal rate.
So, what are they?
1. Concessional super contributions
The first deduction, which is open to people aged 66 or under with less than $500,000 in their superannuation account, is the ability to “top up” any shortfall in the so-called concessional contribution cap of $30,000 this year.
These contributions are made from income that has not yet been taxed. They include the mandatory super guarantee contributions that are paid by your employer as well as “salary sacrifice” contributions. They have a cap each year that is currently $30,000.
The super guarantee contribution on a taxable income of $200,000 is $23,000, meaning there is a gap of $7000 that the person can contribute from their after-tax income and then claim a $7000 deduction.
Analysis by Adrian Raftery, the author of 101 Ways to Reduce Your Tax – Legally, shows if our hypothetical taxpayer earned $180,000 five years ago, and their salary grew by 4 per cent a year to $200,000 today, the gaps over the past five years would add up to $44,400.
That entire amount could be claimed this year as a deduction. The good news with this deduction is the taxpayer is just transferring money from their personal account to their superannuation account – so they are getting a tax deduction but keeping most of their money. Most tax deductions involve payments to somebody else, Balalovski says.
“It’s left pocket, right pocket – it’s leaving your everyday bank account, and it’s going into your superannuation account. It’s still your money,” says Balalovski.
“It’s a very powerful way of getting a deduction.”
Balalovski says you can supercharge that deduction by the little-known strategy of prepaying your concessional super contributions for next year.
“Because you actually physically spent the money this year, you get a deduction this year,” he says. “It’s advantageous if you think that your income this year is going to be greater than next year’s.”
There are some cases where older people can make these deductions, but the opportunities are more limited, says Colin Lewis, the head of strategic advice at Fitzpatricks Advice Partners.
In extreme cases – if you had no employer contribution over the past five years – you would be able to make a tax deduction of as much as $162,500, says Lewis, or even more if you had a self-managed super fund.
“For SMSF members able to use a ‘contribution reserving strategy’ and make a double contribution, it could be as high as $192,500,” says Lewis. Such a strategy involves making a contribution in June but not allocating it until July 28.
“With a second contribution of $30,000, a deduction of up to $60,000 (plus any catch-up concessional contributions) may be available – handy if you’re trying to reduce capital gains tax arising from the sale of an investment property,” he says.
2. Instant asset write-off
A favourite perk of small businesses and sole traders since the 2015 Coalition government has been the instant asset write-off.
The measure allows small businesses with a turnover of less than $10 million to deduct eligible depreciating assets costing less than $20,000.
The even better news is that the $20,000 applies at the asset level, so for a business that bought a car and spent $20,000 on another eligible asset, the deduction could be $40,000.
But the deduction is due to cease on June 30, Raftery says.
“If you have a small business, the $20,000 instant asset write-off is one thing that really sort of stands out… it’s the last year for that. [Then] it ratchets down to $1000,” Raftery says.
Of course, this deduction is only available to sole traders. It does not apply to people who only earn a salary. They must operate a business.
3. Car expenses log book
If the hypothetical salary earner used a car for work, she might be tempted to do the easy thing and just claim this year’s allowed 88¢ a kilometre deduction. Last year, the deduction was 85¢ a kilometre.
But if she keeps proper records of her actual expenses rather than relying on the per kilometre deductions, she could easily triple the size of her deduction.
“If, potentially, they do 5000 kilometres, they can claim a deduction of $4400. But if they did their own logbook, kept all the receipts, it’s not unrealistic that it’s a $10,000 to $15,000 tax deduction instead,” Raftery says.
Keeping a logbook involves recording your kilometres travelled for a 12-week period and recording costs such as car servicing costs, any interest on a car loan, working out the share of depreciation on the value of the car made during work travel, the share of insurance costs and the fuel used, he says.
The above three expenses all involve clawing back tax you have probably already paid. The next one basically defers a future tax payment.
4. Prepaying interest on investment loans
If you have a rental property or an investment loan, you can prepay the interest on the loan that would be due next year, says Raftery. That means you could effectively bring forward a tax deduction that would normally be made next year to this financial year.
Say the hypothetical taxpayer had a $700,000 investment loan at an interest rate of 6 per cent. The annual interest bill on that would be $42,000, says Raftery. “They could prepay $42,000 before 30th of June, if they wanted to.”
Importantly, that will have an effect on tax next year.
“It will shift a potential tax issue into the following year. But you may want to do that anyway because you are maybe going on maternity leave, you may be going overseas. There could be a variety of reasons why you want to bring forward the expenses.”
5. And for the very wealthy, try your own charity
For the very wealthy, it could be worth considering setting up a so-called private ancillary fund (PAF) to make charitable donations.
Raftery says there has been a big increase in these funds from a handful 10 years ago to more than 2000 now.
“What a lot of people are doing if they’ve got a big tax debt likely to happen … is to set up their own foundation and make a tax-deductible donation into that foundation. And so they’ve got effective control over where those monies go into the future.
“There’s probably a heap of CEOs out there who have sold shares from time to time, and they’ve got an impending tax debt, what they could consider is setting up their own foundation, making a tax-deductible donation into their own foundation and still have the direct control of those funds.”
PAFs are required to distribute at least 5 per cent of the market value of the fund’s net assets (as valued at the end of the previous financial year.
What else?
Education expenses are also a good source of deduction, says Pivot’s Nash, along with taking advantage of franked dividends on Australian shares to bring down your overall tax rate.
But an even bigger thing to look at is debt recycling, which is particularly useful for someone who inherits a large sum or simply has some spare cash.
Here’s how that works. If someone has a home loan and $500,000 in a bank account, they could take $499,999 of that money and put in their home loan. They could then redraw the entire amount and use that money to buy an investment such as a share portfolio.
“That means that all the interest costs on that debt are then fully tax-deductible because it’s for investment purposes. And so you’re talking about a really significant tax deduction. If you think the average mortgage size in Australia is like $700,000-odd, then $40,000 a year of the interest on that could then become tax deductible,” Nash says.
“It’s a great strategy. It’s one that we use quite a lot with our clients, particularly the higher-income earners.”
Original article published here in The Australian Financial Review.