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These are some of the more common tax issues that our clients often ask about. Please click on each title to get a more detailed explanation. If you have any other questions please contact us.
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| Business
Many small business owners start out in business trading as a sole trader or partnership due to the simplicity and low cost to establish. This structure is usually satisfactory in the early stages when costs are high and income relatively low. As profits increase the tax effectiveness of these structures diminish significantly. As an example lets look at John & Robyn Smith and their 3 children Peter, Andrew & Penny (all under 18). John started his mechanic business 2 years ago and is now earning a tax profit of $50,000. As a sole trader he would be paying tax of $10,350. If he went into partnership with Robyn (who doesn't work) they would each pay tax of $3,225, or a combined $6,450. There is no direct tax advantage of running the business through a company as the company tax rate of 30% is higher than John & Robyn's marginal tax rate of 16.5%. If John & Robyn established a family trust to run the business, they could distribute $2,667 to each of the 3 children ($8,000 in total) and the remaining $42,000 would be distributed to John & Robyn equally at $21,000 each. John and Robyn would each pay tax of $2,565, and the children would pay no tax at all. The total tax payable by the family would be $5,130. This is less than half of the tax payable if John was operating as a sole trader. The trust also has the benefit of protecting John & Robyn's personal assets from the reach of business creditors, and vice a versa the business assets are protected from the reach of personal creditors. The family trust is also able to vary it's distribution in the most tax advantaged way each year, whereas all other structures are fixed in their distributions of profit. The cost of establishing a trust and a corporate trustee is $1,700, which will be recovered in tax savings within the first year in most cases. Get some good advice about tax planning before year end Once the 30th of June has passed there is very little that can be actively done to minimise your tax liability. In contrast, tax planning is an opportunity to review your business tax performance to project what is likely to be your tax liability for the current year. We usually conduct tax planning in April/May to allow sufficient time to put in place effective strategies to minimise your tax liability. Tax planning is an opportunity to consider whether strategies such as deferring income, prepaying expenses, contributing to superannuation, buying & selling assets, and other tax effective strategies will be effective or how much is needed to reduce your total tax liability. Consider deferring income and prepaying expenses prior to year end Taxpayers on a cash basis (ie; professionals, tradesmen, other business not trading in stock) are only taxed on income actually received. So, an easy method of deferring taxable income until the following year is to not get paid until July. Taxpayers on an accruals basis (ie; companies with trading stock, large business) are assessed on income when it is invoiced, not necessarily when paid. So, the easiest method of deferring income is to not invoice work until July. But, most businesses will be able to claim tax deductions for most business expenses when they are incurred. Generally incurred means that you have an invoice to pay, but legally it means that you have a legal obligation to pay, and so a quote may be sufficient if work has commenced. Most small businesses can also claim expenses that are prepaid up to 12 months in advance. When considering the deferral of income or prepaying expenses, the cashflow impact on your business should be taken into account, although you may be able to borrow funds to prepay expenses, and also claim the interest on the borrowings. Also, it is important that any prepaid expenses are only expenses that you would have paid for in the next year anyway. There is no point in spending money just to save tax. Consider how assets are financed (ie; lease, chattel mortgage, equipment loan, hire purchase, cash) The way that an asset is purchased defines the tax benefits of that purchase. A lease is only tax deductible on the lease payments, and the GST can only be claimed on each lease payment. A lease may also be able to be prepaid up to 12 months in advance. An asset financed by chattel mortgage can claim depreciation on the GST exclusive price, and also interest on the loan. If you are on a cash basis for GST then the entire GST can be claimed back in the next BAS. An equipment loan is identical to a chattel mortgage. A hire purchase is similar to a chattel mortgage for tax purposes, but GST can only be claimed over the term of the finance. An asset purchased with cash is identical to a chattel mortgage, except obviously no interest is charged. Buy depreciable assets for less than $1,000 Most small businesses can claim a 100% tax deduction for depreciable assets with a GST exclusive cost of less than $1,000. Keep this in mind when purchasing assets as assets over $1,000 can only be depreciated at 30%. From 1 July 2007, superannuation contributions made by the self employed are 100% tax deductible. Those businesses operated through a company or trust were already able to claim a 100% deduction. The tax benefit of superannuation is the difference between your marginal tax rate (31.5% for the majority) and the superannuation contributions tax of 15%. So 16.5% is the effective tax benefit of contributing to superannuation. Although access to your superannuation is restricted until at least 55, if you expect to live that long, then it is an effective low tax environment to invest your money. If you want to retain control of your money, then you may want to consider establishing a self managed super fund. One point to remember.....superannuation contributions are only deductible if actually paid, and that means that the super fund has actually received the money. You may also be eligible for the co-contribution of up to $1,500 on after tax contributions, that don't attract a tax deduction. There is no tax benefit of after tax contributions, but you may be getting a 150% guaranteed return on your money. Who can argue with that? If you are also employed, consider salary packaging your business expenses If you run a business in partnership, are also employed, and your taxable income is significantly higher than your partner, you can salary package the partnership expenses from your employment income. This means that you get to claim the business tax deductions, and then split the business income with your lower taxed partner. Assuming your partnership income is $50,000, partnership expenses of $20,000, your employment income is $80,000 and your partner has no other income, normally you would pay total tax of $26,025 and your partner would pay $1,575. If you salary package all the partnership expenses from your employment income, your taxable income will be $85,000 with tax payable of $21,875. Your partner's taxable income will be $25,000 with tax payable of $3,225. Your total tax payable will be $25,100, compared to previously $27,600, a $2,500 tax savings. A similar strategy can also be applied if you run loss making a business that does not meet the non-commercial loss rules.
Employee Salary packaging a car has commonly been thought of as only beneficial to high income earners. This is not correct as it depends upon factors such as the value of the car, distance travelled and business use. Generally, a car with it's value less than $28,000 and annual kilometres of at least 20,000, will be beneficial for anyone to salary package if they are in the 30% tax bracket ($30,000 - $80,000). The business usage is important if it is at least about 40%, but otherwise it doesn't matter as there are various methods for calculating fringe benefits tax on cars. If your employer does offer this then it is definitely worth getting some specific advice as to your circumstances and benefits. A more advanced strategy is available to families with one main income earner. This strategy involves the spouse leasing the car to the employer, who then provides the car to the main income earner and the lease payments, etc are salary packaged. The net effect of this strategy is to divert income from the higher earner to lower earner at a reduced tax rate. Salary package your new laptop computer
Get income protection insurance Income protection insurance is tax deductible, and it provides an income replacement of around 75% of normal salary if you are unable to perform your normal work duties. If you salary package this you can also claim the GST back through your employer. Salary sacrifice into superannuation The tax benefit of contributing pre tax salary into super is simply the difference between your marginal tax rate and 15% contributions tax. Please refer to the article in business for more info. If eligible, contribute after tax money into superannuation If your taxable income is less than $28,000 and you contribute after tax money into superannuation, the Government will also contribute an additional $1.50 for every dollar that you contribute, up to a maximum of $1,500. This means that if you contribute $1,000, the Government will contribute $1,500. That is an almost immediate 150% gain on your investment. You cannot get that return anywhere legally, or extremely luckily! If your taxable income is greater then $28,000, but less than $58,000, the amount that the Government contributes reduces by 5% for each dollar above $28,000. So an effective strategy is to reduce your taxable income below the $58,000 threshold by salary sacrificing into super, and then also contributing after tax into super to get the co-contribution. Not only do you get a great return, you're boosting your super balance. Borrow money to invest or start/buy a business Investing is the cornerstone to creating wealth, and borrowing money is the best way to magnify the performance of your invested dollar. Borrowing to invest, or gearing, allows you to increase the amount that you invest, and as such the return on your investment is magnified. The optimal gearing level is a personal and economic question, but do remember that risk and return are absolutely related, the higher the return...the higher the risk. Gearing magnifies your investment return and so naturally it magnifies both gains and losses. This needs to be understood before entering into gearing, otherwise you could be in for a nasty surprise! As an example, if you have $1,000 and expect a 10% return, then you will earn $100 per year. If you borrow at 50% gearing then you will have $2,000 invested, earning $200, but you will have only invested $1,000 of your own money, so now a 20% return. Conversely, if the investment loses 10% then without gearing you would lose $100, but with gearing your $2,000 invested would reduce by $200, or 20% of your $1,000. Gearing is a smart strategy in the right circumstances, and often it is silly not to borrow, as your investment should be expecting a positive return and so why not increase that return by sing someone else's money? Similarly, borrowing to buy or start a business has the same principle as other investments, although a business would usually be a much riskier proposition that shares or property. The great thing about your own business, is that you have a great impact upon the potential return that you can earn from the investment, and the sense of achievement is enormous when you are successful. Consider earning employment income through a business entity Although the tax office has introduced many rules in respect of earning employment income (Personal Services Income) through a business entity such as company or trust, there are still many advantages to this strategy. Assuming that the PSI rules cannot be met, and thus the income is effectively regarded as employment income, the business can basically only claim deductions that would be available to an employee. This may not sound so great, but there are many tax laws that relate to employees, but because the employer does not want to have the extra administrative work, the employee misses out. Most of the tax advantages come under Fringe Benefits Tax (FBT), and not actually income tax laws. For example, an employee may be able to save tax by salary packaging a car, but the employer is not interested, and so the employee misses out. If you are an employee of your own company, you can do the administration of the salary packaging in conjunction with your accountant, and your real employer does not have to worry. So you get more money in the pocket and things are business as usual for your employer. Another advantage is that you can register for GST and claim the GST on all your work related expenses. This could easily save you a few hundred dollars a year itself, although you would need to lodge a BAS, but this may be an annual BAS, that can be done at the time of doing your tax return. These are just two of the many advantages of employment through a business entity. Please contact us for more ideas, and whether or not it will suit you. Investor As per the similar point in Business, the way that you hold your investments (investment structure) can have a dramatic effect on not only the amount of tax you pay, but also your family tax benefit and the protection that is provided if you become involved in a legal battle (someone sues you or you go bankrupt). Generally, the person with the lowest marginal tax rate and likelihood of legal action should hold the investments if they are positively geared. The opposite is true for negatively geared investments. Joint ownership can provide a mix of tax benefits and asset protection. A family trust is ideal for positive and negative geared investments, but there are a few different types of trusts that will suit different circumstances most appropriately. A self managed super fund is a low tax structure, but obviously has many restrictions on what type of investment and access to the funds. A company is very rarely advised to be used to hold investments, as it is not eligible for the 50% capital gains discount, and asset protection is not ideal. Review your investment performance on a pre & post tax basis Although tax should not be the main reason for investing in a particular product, it is certainly an important area to consider when assessing the performance of an investment, due to the decaying effect it has on your wealth. Every circumstance can benefit from assessing the tax effect of your investment, but also, the investment should be able to stand on it's own without the support of the tax system. The tax system is likely to change over time, and if your investment is just relying upon tax breaks to perform then you might be investing in a riskier asset than you thought. Could you imagine what would happen to many property investments if negative gearing was outlawed by government in response to housing affordability? Get a depreciation report prepared for all your investment properties When you buy an investment property, you are usually buying the land, the original building, building improvements and other items such as carpet, hot water systems, blinds, etc. There are different tax treatments to each of these items and a depreciation report prepared by a qualified quantity surveyor, or similar, will enable you to claim depreciation or capital works deductions on these items. Effectively, you get to write off part of the items value each year against the rent income on the property. Although a depreciation report may cost between $500 and $1,000, most firms will guarantee that you will increase your tax refund by at least this amount in the first tax year. Let's look at an example. John buys a property for $250,000. A quantity surveyor's depreciation report is prepared for the property. The report breaks down the cost or value of the property like this; Original building cost $130,000 in 2007, building improvements $25,000 in 2007, carpets $2,400, Blinds $800, Hot water system $700, various other depreciable items $900. John would be able to claim a 2.5% capital works deduction on both the original cost of the building ($130,000) and the building improvements ($25,000), a 10% depreciation claim on the carpets ($2,400), a 18.75% depreciation claim on the blinds ($800) and hot water system ($700). The total capital works and depreciation claim would be; Original building cost $3,250, Building improvements $625, Carpets $240, Blinds & Hot water system $281 = $4,396. If John's marginal tax rate was 31.5% (his taxable income is between $30,000 and $75,000) he would receive a tax refund of $1,385, well in excess of the cost of the depreciation report, which is also tax deductible. Even if you have owned a property for some time and don't have a depreciation report, a quantity surveyor is qualified to make estimates of values and so it is still worth getting one prepared. If you hold investments with your spouse, consider salary packaging expenses This strategy works in the same way as the point in business. Buy land with the intention to build and rent Interest, rates & insurance on land purchased with the intention to build upon to then rent can be claimed as a tax deduction now. This can have a large negative gearing effect on your tax and can really help with meeting the loan repayments during the time of construction. Buy your first home in your own name, then move out and rent it after 12 months Buying your first home in your own name will allow you to access the stamp duty concessions and first home owners grant. Then after 12 months occupancy, move out and rent the property. You have the choice to maintain this as your principle residence for capital gains tax (CGT) purposes for up to 6 years. That means that you can be negatively gearing the property for 6 years and then sell it CGT free! The main catch with this strategy is that you can only claim one principle residence at a time. The sale contract date is the relevant date for calculating capital gains tax (CGT). So it is important to consider this date as to whether or not you are eligible for the 50% CGT discount. Also, delaying or bringing forward the contract date can be an effective tool for tax planning and reducing your CGT liability.
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